InvestorPlace’s Chris Lau recently stated that Southwest Airlines (NYSE:LUV) and LUV stock is the best bet for an air travel recovery.
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I have to say, while I believe Southwest is hands down, the best airline operating in the U.S. today — not to mention the strongest financially — I still think the smarter bet is to buy the U.S. Global Jets ETF (NYSEARCA:JETS).
The World’s a Big Place
One particular paragraph of my colleague’s article made me think of another reason I like the ETF so much.
“When it comes to the ability to recover, Southwest is one of the best-positioned airlines in the U.S. Even though its prospects are uncertain in the next few weeks, investors looking for airline stocks should watch this one first,” Chris wrote July 9.
The key words being the United States.
The world is a big place. We have no idea how fast the American economy will recover now that the country is in full-on panic mode, as the number of novel coronavirus cases reaches record levels.
This is important for two reasons.
Southwest Can’t Afford Another U.S. Shutdown
Southwest operates exclusively in the U.S. If the domestic economy goes into the tank, and people refuse to get on airplanes — middle seat or not — Southwest’s business will be the most affected by a slowdown.
According to Forbes Aerospace & Defense contributor Will Horton, United Airlines (NASDAQ:UAL) generated $16.3 billion in international revenue in 2019, most of the four major airlines not named Southwest. So, that’s 38% of United’s overall revenue. Delta Airlines (NYSE:DAL) had $11.9 billion in international revenue in 2019 (28%), while American Airlines (NASDAQ:AAL) came in third place with $11.1 billion in international revenue (26%).
To put context to Horton’s article, he’s discussing how United’s reliance on international flights could hurt it as the U.S. travel recovery accelerates. And even though the airline is adding domestic flights in a hurry, the ban on travel by Americans to the European Union could hurt it. He points out that United’s business to Europe is its most significant international segment at $7.4 billion, followed by Asia at $5.1 billion, and Latin America at $3.8 billion.
That’s a solid premise.
Horton adds to his argument, pointing out that United has too many wide-body aircraft compared to its peers. And those planes can’t easily be redeployed to the domestic market.
But what happens if these three international markets experience an economic renaissance while the U.S. flounders under its directionless leadership? Southwest and all the other airlines relying on a domestic economic recovery are up the creek without a paddle.
Should the U.S. shutdown again, United CEO Scott Kirby ought to be tickled pink that he has almost 200 wide-body jets to service the global air traveler. Here in the U.S., we tend to forget that there’s a whole world beyond our borders doing business and making money. United’s weakness could become its strength.
Meanwhile, what does Southwest do in this situation? It has no backup plan. It’s America or Bust.
Now, like most things in life, what happens in situations like this is usually somewhere in the middle between a worst-case and best-case scenario. So, given Southwest’s better prepared for a more extended downturn than its three peers, it ought to survive a second shutdown.
This brings me to the topic of geographic diversification.
JETS has a U.S. weighting of 68.44%. Add Canada into the domestic mix (7.57%) and you get a 75/25 split between domestic and international airline-related companies.
While I’d like that to be a little more balanced, it still gives you some protection against a U.S. meltdown. Further, if you add to this the international business of the U.S. airlines we’ve been talking about along with Air Canada (OTCMKTS:ACDVF), it might bump the figure to 65/35.
It isn’t perfect, but it does a better job of balancing risk and reward than betting on Southwest stock exclusively.
The Bottom Line on LUV Stock
In the past, I’ve come up with recommendations that balance an investor’s desire to bet on one particular stock with the understanding that company risk is real.
So, for example, in July 2018, I suggested that if you wanted to put X amount into Canopy Growth (NYSE:CGC), you take half the amount and put it into Constellation Brands (NYSE:STZ). Alternatively, you could have put 50% into the ETFMG Alternative Harvest ETF (NYSEARCA:MJ).
Here’s how you would have done under all three scenarios:
- 100% Canopy Growth = -43.9%
- 50% Canopy & 50% Constellation = -28.0%
- 50% Canopy & 50% MJ = -48.0%
Unfortunately, the cannabis industry in Canada took a major step back in 2019 but now seems to be slowly getting its act together. Long-term, I don’t think a 50/50 split between Canopy and MJ is a bad decision.
Applying this philosophy to JETS, if you want to bet on LUV, the wiser play remains a 50/50 split between the two.
Sure, you might not make as much should Southwest and the entire airline industry take off, but successful investing is often about protecting your downside than it is reaching for the stars.
Will Ashworth has written about investments full-time since 2008. Publications where he’s appeared include InvestorPlace, The Motley Fool Canada, Investopedia, Kiplinger, and several others in both the U.S. and Canada. He particularly enjoys creating model portfolios that stand the test of time. He lives in Halifax, Nova Scotia. At the time of this writing Will Ashworth did not hold a position in any of the aforementioned securities.
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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.