Travel demand is recovering as two years of COVID-19-related mobility restrictions and health concerns ease around the world. This offers a sunny outlook for airlines, an industry hit by the fallout from the pandemic.
Leading North American airlines are seeing an increase in booking activity due to factors such as pent-up demand, “revenge travel” and consumer willingness to shrug off soaring jet fuel prices amid sanctions against Russia, a major oil producer.
These trends indicate multi-year growth in the travel and tourism industry. Investors should take a closer look at the following undervalued airline stocks in Morningstar’s coverage universe.
Canada’s largest airline, Air Canada (AC), together with its regional partners, carries nearly 50 million passengers each year. The airline is a sixth freedom airline, similar to Gulf airlines, that flies many US citizens on long-haul flights with a stopover in Canada. The company generated $19 billion in revenue in 2019 before the pandemic hit operations and pushed revenue down to $6 billion in 2020.
The Canadian carrier is internationally oriented, with only about 22% of its 2019 capacity being used for domestic flights.
“We anticipate a short-haul recovery geared towards leisure and believe Air Canada’s low-cost carrier, Rouge, will continue to offer a low-cost product that competes effectively [rivals]’ according to a Morningstar stock report.
The company’s long-haul leisure travel is dependent on the global spread of the COVID-19 vaccine and “will keep capacity low longer until international travel demand returns,” says Morningstar equity analyst Burkett Huey, noting, that Air Canada entered the COVID-19 -19 crisis in better financial shape than many US-based competitors.
The pandemic was the sharpest demand shock in airline history. However, the reopening of borders offers Air Canada a path to recovery.
Management intends to fly approximately 66% of Q1 2019 available seat miles in Q1 2022. “The company will finally be able to reallocate some long-haul capacity in 2022,” said Huey, who put the stock’s fair value at $28.
The airline’s frequent flyer program, Aeroplan, which it reacquired in 2019, is popular with frequent flyers and “provides a high-margin revenue stream for the airline,” Huey says.
Delta Air Lines (DAL) is one of the largest airlines in the world. The network extends to more than 300 destinations in more than 50 countries. Delta operates a hub-and-spoke system network, carrying passengers around the world through key locations such as Atlanta, New York, Salt Lake City, Detroit, Seattle and Minneapolis-St. Paul.
“Delta is the incumbent airline with the highest quality because of its ability to attract high-profit business travelers through its product segmentation and credit card partnerships, primarily with American Express,” according to a Morningstar stock report.
Delta co-branded cards alone account for about a fifth of American Express’ loan book.
The legacy airline’s five-cabin segmentation strategy allows high-spend travelers to purchase premium options. “Frequently, business travelers use miles from a co-branded credit card to upgrade flights when their company is unwilling to pay a higher price,” says Huey, noting, “Delta can continue to grow this higher-margin business post-pandemic.”
Delta will continue to target high-yield business travelers, although the market may remain difficult for now, he adds.
Huey forecasts a full recovery in capacity and an 80% to 90% recovery in business travel, which will then grow to GDP levels over the medium term. “We think Delta is well-positioned to weather the pandemic, but its strategy of extracting value from business travelers will be challenging in a low-pricing environment,” said Huey, who recently estimated the stock’s fair value at US$54.50 -dollar to $57, prompted by the pace of the aviation recovery and mid-cycle operating margin.
The US’s largest domestic airline, Southwest Airlines (LUV) operates over 700 aircraft in an all-Boeing 737 fleet. Despite expanding to longer routes and business trips, the airline still specializes in short-haul leisure flights, using a point-to-point network.
“Southwest’s customer-centric tactics benefit the company by providing the closest brand equity in the airline industry,” according to a Morningstar stock report.
More than 85% of Southwest’s revenue comes through its own distribution channel, while other airlines rely more heavily on third-party providers to acquire customers.
In the leisure market, Southwest faces competition from ultra-low-cost carriers, “but we believe Southwest’s customer-friendly tactics allow it to target higher-income demographics,” says Huey, who expects commercial aviation to continue to expand The recovery will see the reverse of leisure travel, “reflecting customers’ greater willingness to visit friends and family and take vacations in a pandemic than they do to travel on business.”
However, Southwest is also courting higher-yield business travelers to support growth. A structural lack of transoceanic routes and premium options may limit Southwest’s ability to attract its highest-earning business travelers, but the airline’s “focus on delivering low fares and its relatively new global distribution system, which allows for bulk purchases of reservations, should allow it to take on business travel while business travelers try to cut costs,” argues Huey, who recently raised the stock’s fair value from $63 to $65 on a rebound in air travel.