In my last article on United Airlines (NASDAQ:UAL), I urged investors to wait until UAL stock reaches adjusted book value of $16.87 per share. But I have changed my mind. I don’t think the stock will get that low.
United’s book value as of March 31, was $9.418 billion, or $38.09 per share. But this quarter, it will incur about $45 million per day of cash burn. That lowers book value by $4.095 billion to $5.313 billion. In addition, United raised $1.2 billion in new equity, so the revised book value is likely closer to $6.5 billion.
However, if you add in the extra shares, plus the government warrants, as I pointed out in my last article, the extra dilution to the denominator, or shares outstanding, is 22.9%. The existing shares are 290.4 million, so the diluted shares outstanding will be 356.9 million. That brings estimated adjusted book value at the end of Q2 to $18.21 per share ($6.5 billion divided by 356.9 million shares).
So right now UAL stock, at $29.46, is trading at 1.6 times its adjusted book value. But now I’ve changed my mind about how to value it.
Why I Decided To Change My Mind About UAL Stock
I decided to forget about taking a price-to-book value approach to UAL stock. Granted, this is a cyclical stock, and that approach might be feasible in normal cyclical times. But this isn’t a normal recession. It wasn’t caused by normal excesses or weaknesses in the economic system. It was caused by an exogenous event. Therefore, a rebound in demand is likely to be gradual … and “cure event” dependent.
I suspect the UAL stock is going to rally based on 1. any uptick in demand for travel, or 2. any concrete evidence that a vaccine for Covid-19 is now feasible.
There is already evidence that a good deal of pent-up demand for air travel is picking up. First of all, the company said in its latest earnings release conference call that it expected its daily average cash burn would fall to $20 million per day by the fourth quarter.
This is similar to what Delta Air Lines (NYSE:DAL) management is telling investors. That would reduce its cash burn to just $1.8 billion or less by Q4.
Additional Reasons
Second, the company says that once the demand is at 50% of last year’s (from much worse levels), it expects to be able to reach breakeven in cash flow. The new CEO, Scott Kirby, who moved up from being president of United Airlines about a week ago, said this himself.
Third, it looks like Kirby is a good choice to run the airline. CNBC reports that he has quite a reputation. He is known as an “action-taker,” willing to take risks. He specializes in “maximizing revenue through growth.” That is the kind of change that United Airlines needs.
For one, Kirby told the Bernstein there was a zero percent chance that United Airlines would file for bankruptcy. He said it was a “dumb” idea. He said it would be the “absolute last thing that we would do.” He said, “It’s worse for shareholders, creditors, employees. It’s worse for every constituent that we have.” That is a very definite message for existing shareholders of UAL stock to take to heart.
Next, on May 27, he published plans for the company to dramatically cut its costs. In a press release the company announced that COO Gary Hart would be retiring from that role and the company said it was considering further cuts in labor costs to increase “flexibility in its cost structure.” This is important now to match expenses with lower revenue.
What To Do With UAL Stock?
At this point, I do not have a price target for UAL stock, even though I have abandoned the price-to-book-value approach. I suggest, though, that the slightest uptick in demand or news of a Covid-19 cure will dramatically raise the stock price.
Investors are likely to move first here to push up the stock, and then ask later how high should it go. The reason is that as demand for air travel rises, United will be a beneficiary.
People tend to be creatures of habit. As soon as they can safely get back to taking vacations, by air travel, they will. That will tend to push up the stock close to its previous revenue and cash flow over time.
At first, the company will report difficult profits and cash flow. But the market tends to discount the future. I suspect that UAL stock will be discounting future profits fairly soon.
As of this writing, Mark Hake, CFA does not hold a position in any of the aforementioned securities. Mark Hake runs the Total Yield Value Guide which you can review here.