A first look at United Airlines following a pitch from the Robin Hood Investors Conference
I attended the annual Robin Hood Investors Conference yesterday. And as always, I came away with some great investment ideas...
One of them was United Airlines (UAL), pitched by Jack Woodruff of hedge fund Candlestick Capital. He expects shares to more than double over the next two years.
His pitch was publicized in this Bloomberg article, which details his reasoning:
Ongoing structural changes in the air travel industry are under-appreciated by the market, Woodruff told an audience at the JPMorgan/Robin Hood Investors Conference on Wednesday. He said so-called network carriers like United will ultimately benefit...
I've generally avoided this sector, for reasons outlined in Warren Buffett's 2007 annual letter to Berkshire Hathaway (BRK-B) shareholders:
The worst sort of business is one that grows rapidly, requires significant capital to engender the growth, and then earns little or no money. Think airlines. Here a durable competitive advantage has proven elusive ever since the days of the Wright Brothers.
Along these lines, I'll never forget one airline CEO's wise words of warning...
Back in 2003, I interviewed Jonathan Ornstein, the CEO of Mesa Air (MESA). He told me, "You can't own airline stocks. You can only rent them."
That said, nearly a dozen years ago, I invested in JetBlue Airways (JBLU) after hearing a compelling pitch at a different investment conference. As I discussed in my August 27, 2024 e-mail, I nearly tripled my money.
So today, let's take a look at United Airlines to see if history might repeat itself...
The stock has been a dud since going public in early 2006. But despite getting nearly cut in half earlier this year, it has rallied strongly. And it currently sits near its all-time high:
As always, I like to start my analysis by looking at two decades of revenue and operating income (profits):
We can see that United has been consistently profitable, with the exception of 2008 during the global financial crisis and 2020 to 2021 during the pandemic. This is a cyclical business.
It's also a business with high capital expenditures ("capex"). This weighs on free cash flow ("FCF"), as you can see in this 20-year chart:
Note, however, that the past two years have had the highest FCF in United's history.
Turning to the balance sheet, United has always had substantial net debt. Though it has declined the past two years:
Total net debt sits at $18 billion. That's 3.1 times trailing 12-month earnings before interest, taxes, depreciation, and amortization ("EBITDA"), which is reasonable for an airline.
Its net debt is also equal to nearly five years' worth of FCF. That means the stock has levered upside if things go well... but also levered downside if things don't go well, such as a recession or oil price shock.
In 2010, United merged with fellow airline Continental in an all-stock transaction. But other than that, there's almost nothing to report for capital allocation – no cash acquisitions or dividends.
The company made modest share repurchases when it generated positive FCF from 2014 to 2020 and again in the past five quarters:
After the close yesterday, United reported solid third-quarter earnings. So let's get into the details...
At $15.2 billion, revenue was slightly lower than expectations of $15.3 billion.
But adjusted earnings per share ("EPS") of $2.78 beat expectations of $2.63. And the company guided for EPS of $3 to $3.50 for the fourth quarter, above estimates of $2.86.
Turning to valuation, the company has a market capitalization of $33.5 billion. Adding $18 billion of net debt gives it an enterprise value of $51.5 billion.
Adjusting for the increased guidance, analysts expect the company to earn $10.72 per share this year and $13.02 next year.
Earlier this morning, the stock opened around $102. At that price, that means it was trading at 9.5 times this year's estimated earnings and a mere 7.8 times next year's.
These forward multiples are far below the S&P 500 Index average, which is in the low 20s.
Airline stocks almost always trade at low multiples given the highly competitive, cyclical, and capital-intensive nature of the industry. Even during boom times like 2016 and 2017, United never traded above 12 times forward earnings.
In summary, I'm not inclined to chase this stock after its 70% run-up since April.
Given the many risks inherent in the industry, I'm only interested in "renting" these stocks when sentiment is terrible and they're trading near 52-week lows, not highs.
Best regards,
Whitney
P.S. I welcome your feedback – send me an e-mail by clicking here.