In the depths of the 2008 financial crisis, Warren Buffet wrote “be fearful when others are greedy and greedy when others are fearful.” That still seems like good advice. Both our StarMine research and academic research finds that stocks with low valuations tend to outperform expensive stocks. When others are “greedy,” high expectations occasionally disappoint and those who arrive late to the party get hit with big losses. Netflix, with its recent 19% one-day sell-off, comes immediately to mind. So we’re off to find a pocket of fear.
When the first case of Ebola arrived in the U.S., it came by plane. In mid-October, a second Dallas healthcare worker was hospitalized with Ebola, a day after returning from Cleveland on a Frontier Airlines flight. While the Centers for Disease Control says the risk to her fellow passengers is low, it is trying to track down and interview all 132 passengers on the flight.
Concerns about the impact on air travel and airlines’ profits have hammered airline stocks. There are no longer any pure airline ETFs on the market (Guggenheim shuttered the last in March), so the iShares Transportation Average (IYT) and SPDR S&P Transportation ETF (XTN) are about as close as we can get.
Between when Thomas Eric Duncan was hospitalized on Sept. 25 (and later died) after having flown to the U.S. from Liberia, and Oct. 13, IYT and XTN had lost roughly 9% and 11%, respectively, worse than the overall market’s 6% decline.
Over the last 30 days, AAL, parent of American Airlines, has lost 11%, Delta Air Lines 12% and Southwest Airlines 10%, worse than can be attributed to the overall market correction. Since oil prices have been declining, which is usually a positive for airlines, we’ll blame the Ebola scare.
Looking back
How did airlines fare during previous pandemic scares? We’ll rule out H1N1 (swine flu) because it occurred from April 2009 to August 2010, when the market was coming out of the largest downturns of the century, complicating the analysis.
So let’s take a look at the impact from the viral lung disease called SARS. In March 2003, the World Health Organization (WHO) put out a warning about SARS that dramatically affected airline stocks. For instance, from Jan. 15, 2003, before the warning, to April 1, 2003, Alaska Air lost 51% of its value. Yet by the end of 2004, the stock had rallied back 73% from its low.
Given the huge, although temporary, declines in airline stocks during the SARS scare, there could certainly be more downside risk to airlines in the current situation. However, unlike SARS, Ebola is not an airborne pathogen. So it may be worth considering the hypothesis that U.S. airlines might be oversold.
While we’re quoting Warren Buffett, we should probably acknowledge that he also wrote about the turbulent airline business: “a durable competitive advantage has proven elusive ever since the days of the Wright brothers. Indeed, if a farsighted capitalist had been present at Kitty Hawk, he would have done his successors a huge favor by shooting Orville down.”
We don’t have a measure of durable competitive advantage but, when sifting through this industry, we have attempted to eliminate the riskiest companies – those that might have difficulty maintaining profits, or have less-robust balance sheets. Toward that end, we eliminated companies with a StarMine Combined Credit Risk model rank below 20 and then placed equal weight on Earnings Quality, Relative Valuation and Intrinsic Valuation — a way to screen for higher-quality, less-fragile, and potentially-undervalued airlines. The combined rank, based on the attractiveness of this equally weighted three factor model, is shown in the screen below.
Source: Eikon/StarMine
Domestic vs. international
As a coincidence, three of the top four airlines in our universe have a domestic focus. Although the second U.S. healthcare worker who developed Ebola previously took two domestic flights, it’s possible that domestic airlines might fare better if international travel fears, or outright bans, intensify. Of these four stocks, Southwest is not the least expensive, but it does have the highest Earnings Quality score, as we profiled in this Oct. 10 Alpha Now report.
Looking more closely at valuation, the Relative Valuation table below shows the top ranked stock, Alaska Air, compared to a collection of its peers. It shows that ALK.N trades at a discount to its peers’ median trailing P/E, forward EV/EBITDA and dividend yield.
Source: Eikon/StarMine
Judging runway speed
It’s possible that Ebola turns into a “black swan” event – unpredictable and market-rattling. It’s certainly a virus that we all hope to see eradicated from the face of the earth. But history suggests that fear spreads faster than disease. Determine for yourself if that fear is overdone. If so, it might be worth spending some time poking around the airlines now that they’ve been tossed into the bargain bin. Market signs are positive – this collection of stocks has inched higher recently, but are they ready to take off?
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