International Flight Isn't Delayed, Investors Are Just Early

Since the pandemic started, it’s been clear that business and international air travel would be among the the hardest-hit sectors of the economy and one of the last to recover. Even as some countries start to reopen their borders, that hasn’t changed. Fear of Covid variants that can elude the protection offered by vaccines means many governments will keep myriad restrictions and requirements in place that will make cross-border travel more expensive at best and completely unfeasible at worst. As for businesses, they will want to have employees back in the office before they start sending them around the world on planes. If you’ve strolled around New York City’s skyscraper-heavy Midtown neighborhood lately on a weekday, you know we’re not quite there yet.

The stock market, however, is already trading as if this whole Covid thing is over. That mismatch sets up the kind of ugly day airline stocks had on Tuesday: The S&P 500 Airlines Index fell about 4.6% in one of the worst showings this year for the gauge. The first apparent trigger for the selloff was an announcement that the U.S. State Department is changing how it determines travel advisories to better align with health assessments from the Centers for Disease Control and Prevention and reflect on-the-ground logistics for factors such as testing capacity. The second was United Airlines Holdings Inc.’s earnings, which were released after the market closed on Monday. The company recorded a wider-than-expected first-quarter loss amid rising costs and took a conservative view on flight capacity and revenue for the current quarter despite early signs of a demand recovery. 

International Flight Isn't Delayed, Investors Are Just Early

Airlines are one of the few sectors that haven’t fully recovered from the pandemic slump, but they’ve rebounded enough that there’s little room for unexpected detours from the recovery narrative. So when there’s bad news, the instinct seems to be to sell first and ask questions later. But this particular round of “bad news” doesn’t look too terrible upon closer analysis. 

For example, the State Department’s travel-advisory adjustment appears to be more of a bureaucratic change than a practical one. The new approach will result in about 80% of the world being classified into the “do not travel” category. But Americans are currently prevented from entering many countries anyway, and the State Department emphasized that the change doesn’t necessarily imply a reassessment of public health conditions. In fact, such a data-driven ranking of health risks — ideally with a corresponding alignment of testing or quarantine requirements — is exactly what the airline industry has been clamoring for as a way to safely restart international travel. The State Department’s approach to Covid travel warnings doesn’t sound all that different from the U.K.’s “traffic light” system for assessing Covid risks country by country. But in this case, to the benefit of the airlines, the U.S. advisories are technically nonbinding. 

Mexico and Caribbean countries such as Antigua and the Dominican Republic have recently been bright spots for U.S. airlines, but they are labeled as “very high” risk for Covid by the CDC and as “do-not-travel” zones by the State Department under these new parameters. That may be a big concern for investors. However, the accessibility of cross-border travel for U.S. citizens remains highly dependent on the destination country’s rules. As for coming back home, the U.S. officially requires only proof of a recent negative Covid test or recovery from the virus for passengers arriving in the country in most cases. And Americans’ pent-up demand for international travel shouldn’t be underestimated. United believed Mexico’s Covid testing requirements would dampen interest in visiting the country this spring, so it cut capacity to the beach resorts there. “Well, we were wrong and we quickly reinstated that capacity,” United’s Chief Commercial Officer Andrew Nocella said on a call Tuesday to discuss the company’s results. In fact, United’s flying capacity in the parts of Latin America where travel is permitted is now above 2019 levels, he said. 

International Flight Isn't Delayed, Investors Are Just Early

United investors, however, looked right past that comment and other bullish signals and fixated on the negative. Shares of United tumbled as much as 10% for the worst decline among major U.S. carriers on Tuesday. The company said it’s planning to fly 45% fewer seats than it did in the same period in 2019 and expects total revenue from each seat flown a mile to be down about 20%. The company linked a return to positive net income to a recovery in business and international travel to 65% of 2019 levels but said it may be able to get to a positive adjusted Ebitda figure by the fourth quarter even if demand in those markets climbs back to only 30% of what it was before the pandemic. 

Those forecasts are more pessimistic than some of its peers. Delta Air Lines Inc. — which also got dinged by investors last week over rising costs as it brings pilots up to date on training and puts planes back into service — had forecast a 32% decline in its scheduled seats and a 40% drop in sellable seats in the same period. (The divergence between the two reflects Delta’s decision to keep the middle seat empty through May 1.) Delta is targeting a return to profitability by peak summer. American Airlines Group Inc. has said it expects to put most of its fleet back in service in the second quarter and fly 80% of its 2019 international  capacity in the summer. The airline will likely give a more detailed update when it reports results on Thursday. 

But United relies heavily on business and international travel, which historically accounted for two-thirds of its revenue. With those markets still down more than 80%, a more conservative capacity plan is justified, CEO Scott Kirby said. “It's not likely that that's going to change tomorrow,” he said on the earnings call. “We could fly 40% more capacity. I would probably generate 10% more revenue and we'd probably drive 20% more costs and so we would burn more cash.” Instead, United’s cash flow turned positive in March — after stripping out severance and rebuilding expenses as well as the impact of the government’s payroll support, among other things — and it expects this trend to continue. As evidenced by the Mexico example above, United is clearly ready to pivot and add flights if demand proves stronger than expected. It also swiftly announced  new routes to Greece, Croatia and Iceland this week after those countries lowered the barriers for entry. The airline just doesn’t want to get into a jam because of overly rosy assumptions. 

This shift away from the airline industry’s past bad habits of chasing revenue and market share at any cost is allegedly what investors have demanded for years in the industry. You would think they might appreciate of United’s continued commitment to discipline, but the realism appeared to only remind investors of how dependent United is on business and international travel. The trajectory of the recovery in those markets does indeed remain unpredictable. But more than a year into this pandemic, that shouldn’t be a surprise. 

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Brooke Sutherland is a Bloomberg Opinion columnist covering deals and industrial companies. She previously wrote an M&A column for Bloomberg News.

©2021 Bloomberg L.P.

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