There's no end to the COVID-19 pandemic in sight. As a result, air travel demand hasn't improved much following a steep drop earlier this year. In recent days, passenger throughput at TSA checkpoints has averaged less than 30% of year-ago levels -- despite widespread availability of bargain airfares during what would usually be the peak summer travel season.
In this environment, U.S. airlines have had to focus on what they can control. Most notably, that includes minimizing cash burn and bolstering their balance sheet flexibility. Last week, Southwest Airlines (NYSE: LUV) gave shareholders good news on both fronts.
Cash burn is slowing -- gradually
Back in April, Southwest Airlines projected that core cash burn would average between $30 million and $35 million a day in the second quarter of 2020. Fortunately, solid cost performance and an uptick in bookings (especially in June) allowed it to beat that forecast. Daily cash burn slowed from $30 million in April to just $16 million by June, putting average daily cash burn for the full quarter at $23 million.
In conjunction with Southwest's Q2 earnings report last month, management said that third-quarter cash burn would likely be in line with the company's second-quarter result, largely due to a slowdown in bookings during July as COVID-19 case numbers surged. Fortunately, a modest decline in reported new cases in recent weeks has paved the way for increased bookings, bolstering cash flow.
On Wednesday, Southwest Airlines said it expects August revenue to be at the high end of its previous guidance range, albeit still down 70% to 75% year over year. Furthermore, based on recent booking activity, it expects modest sequential improvement in September, with revenue down 65% to 75% year over year.
Meanwhile, Southwest has been steadily paring back its flight schedules since the initial uptick in bookings petered out in July. The airline now expects Q3 capacity to be down 30% to 35% year over year, compared to its initial forecast of a 20% to 30% decrease.
The combination of stronger booking activity and fewer flights is good for cash flow. Southwest says that daily core cash burn averaged about $17 million in July -- $1 million better than its initial expectation. Moreover, the company reduced its estimate for Q3 daily core cash burn to $20 million from $23 million previously.
The balance sheet remains rock solid
Southwest Airlines entered 2020 with the best balance sheet in the U.S. airline industry by a long shot. It's been very aggressive in raising additional capital, reasoning that there's no such thing as too much cash in a highly uncertain environment (even if it's incurring some extra interest expense as a result).
Indeed, Southwest held an incredible $15.2 billion of cash and investments on its balance sheet as of Aug. 18. That represented an increase of more than $1 billion since July 23. The company more than offset its cash burn by issuing about $1 billion of additional unsecured debt and receiving its final $326 million disbursement from the government payroll support program.
Based on Southwest Airlines' estimated Q2 cash burn rate of $20 million a day, this $15.2 billion cash stockpile would cover more than two years of cash burn. With demand likely to continue improving at least a little bit and greater flexibility with respect to labor costs going forward, Southwest's cash burn will probably be a good deal lower than that figure, extending its runway.
A solid pick for long-term investors
While Southwest Airlines stock has held up better than most airline stocks this year, it remains far below its pre-pandemic highs. The stock also sits more than 15% below the high it reached in early June, when investors were briefly optimistic about a relatively quick recovery.
Southwest's fortress balance sheet will enable it to weather the pandemic with ease and go on the offensive vis-a-vis weaker rivals once conditions start to improve. When that will happen is still anybody's guess, but with several vaccine candidates having begun Phase 3 trials over the past month, a meaningful recovery could begin as soon as next year.
As an airline stock, Southwest Airlines is certainly a risky investment. However, for patient investors who can afford to take some risk, the long-term upside in Southwest Airlines stock appears to substantially outweigh the potential downside.
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