While United Airlines Holdings, Inc. (NASDAQ:UAL) has already seen a solid rally in the last couple of months, the stock still has the potential for substantial upside from here. The airlines have entered a period of strong profits and free cash flows while the market continues to exclude the sector from the standard industrial transportation valuations. My investment thesis remains ultra Bullish on the airline stock.
Source: Finviz
Topping 2019 Levels
While a lot of airlines racked up large debt levels during the Covid slowdowns back in 2020 and 2021, the companies are now generating massive profits and free cash flows with sights on topping 2019 levels. United Airlines actually continued to forecast a massive EPS of $10 to $12 for 2023, yet the stock only trades at $56 following a major breakout this week.
The airline, along with the sector, reported a small loss during Q1 completely throwing off the stock market. Somehow the losses in the seasonally weak quarter threw investors off track despite the persistent large yearly EPS target of $10+.
At the time of the Q1’23 earrings report, United Airlines targeted a $3.50 to $4.00 EPS for Q2’23 alone. The market initially ignored this number, but Delta Air Lines (DAL) hammered home the potential for a record Q2 EPS at their Investor Day on June 27.
The market was very positive on the airline stocks heading into the Delta meeting, but the guidance appears to have finally altered the mood on the stocks. Despite all the recent gains, a major disconnection remains on valuations.
Jefferies analyst Sheila Kahyaoglu went on CNBC after raising her price target on Delta to $50 from $45. The analyst made the following perplexing statement:
If you value Delta on its 2025 free cash flow target, it’s trading at a 13% free cash flow yield. The market is at 5.5. We could see upside of up to $100 on Delta shares, if they hit their targets.
Despite a very bullish statement regarding the upside on Delta based on admitted conservative 2025 free cash flow targets of $4+ billion, Ms. Kahyaoglu has a price target just above the current stock price. In fact, the Jefferies price target on the stock would normally only warrant a Hold on the stock the analyst suggests could more than double to reach $100.
Industrial Transportation Comps
The industrial transportation industry is a diverse group from airlines to railroads to cruise lines to package delivery services. The sector currently has a common theme of related stocks trading around 15x forward earnings estimates outside of the airlines.
The amazing part is that Covid had varied impacts on the sector. The cruise lines were shut down until 2022 and are only now hitting full capacity in early 2023 while package delivery firms saw a big boost in demand leading to a current slowdown.
The airlines started reporting massive profits last year, yet a cruise line like Royal Caribbean Group (RCL) has already doubled this year prior to reporting forecasted large profits. In addition, United Parcel Service (UPS) and Union Pacific (UNP) have all returned to a 15x P/E multiple.
United Airlines could double to $112 and the stock would only hit a 10x froward P/E multiple. The airline stock would still trade at a massive discount to the other industrial transport stocks.
In addition, this forward P/E target is based on United Airlines earning an $11 EPS in 2024. The airline has already guided to hitting this level in 2023, suggesting the company could reach a $13 EPS in 2024 and the stock would have to hit $130 to reach a 10x forward P/E multiple.
United Airlines ended last quarter with a net debt total of only $13.5 billion due to generating positive cash flows from surging advance ticket sales up nearly 50% YoY to $10.2 billion, while the cruise line stocks have rallied despite similar or larger debt issues. Naturally, risks exist, but the other industrial transportation stocks face a lot of the same risks without the stocks being held back.
Takeaway
The key investor takeaway is that United Airlines stock remains an insanely cheap stock. The airline sector definitely isn’t without risk, but the stock should be bought on this breakout due to the solid risk/reward scenario where United could still double from there.
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