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April 14, 2022

Remember the bet on rebounding airline stocks? It’s now worth another look

Airline stocks have been a disappointing bet over much of the past year: We are more or less free to travel, yet stocks such as Air Canada, Delta Air Lines Inc. and Southwest Airlines Co. are still well off their highs.

But the impressive gains on Wednesday, following upbeat quarterly earnings from Delta, suggest that a bet on the sector’s recovery might still be worth pursuing.

Airline stocks cratered in the early stages of the pandemic, when lockdowns grounded planes and airline survival was an open question amid alarmingly large losses. Air Canada shares fell as much as 75 per cent in the first three months of 2020.

But the stocks are a key element of the so-called reopening trade – a group of companies that also includes cruise lines, cinemas and malls, which some investors expect to rebound sharply as the economy reopens and lives return to normal.

A year ago, as vaccines rolled out and authorities eased up on travel restrictions, the trade appeared to be paying off: In April, 2021, many near-dead stocks were up 100 per cent to 200 per cent from their pandemic lows.

But the strategy has floundered over much of the past 12 months.

In the case of airlines, Southwest is down 32 per cent over the past year (prior to Wednesday’s rebound). United Airlines Holdings Inc. is down 24 per cent over the same period, and the shares are still 50 per cent below their price at the start of 2020.

Air Canada fits right into the trend: The shares have fallen 23 per cent from their recent highs in June, and they are 56 per cent below their record highs in 2020.

However, the underpinnings still look compelling and are supported by Delta’s quarterly financial results released on Wednesday.

The airline reported a loss of US$940-million over the three months ended March 31, a period when the Omicron variant disrupted travel plans. However, the U.S. airline said that it was profitable in March and indicated that a return to normal is within reach as demand for travel surges.

Delta said that it will operate at 84 per cent of its 2019 capacity in the second quarter, as demand for both business travel and tourism picks up in spite of soaring costs.

Although Delta’s fuel costs surged 33 per cent over the previous quarter and are expected to rise further in the second quarter, airlines have been passing on these additional costs to consumers.

According to Hopper Price Tracker, the average round-trip U.S. domestic airfare this month is approaching US$350, up almost 50 per cent since the start of the year and higher than April ticket prices in 2019.

“Consumers have not been travelling over the past two years, so this is a category they are prioritizing,” Ed Bastian, Delta’s chief executive officer, said in a conference call with analysts.

Delta’s share price rose 6.2 per cent Wednesday, suggesting that investors are embracing the optimism.

The stocks of other airlines also rallied, signifying that Delta is perhaps not an outlier. Air Canada’s share price gained 5.8 per cent and Southwest rose 7.5 per cent.

Are there still elements to air travel worth worrying about?

Definitely. Rising interest rates could slow the recovery or perhaps push the North American economy into recession. And the Omicron subvariant, which has disrupted travel in Europe, shows that the pandemic is by no means over.

But with airline stocks still far below 2019 levels, the downside risks appear to be largely built in to share prices. What’s not built in: Travel patterns returning to normal as more routes reopen, consumers willing to pay more to get away and airlines returning to profitability.

The reopening trade has stalled. But it’s not dead.

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