In the last four years, airline stocks have been wrestling with multiple headwinds. First, the COVID-19 pandemic brought the travel sector to a screeching halt for two years. Several countries relaxed lockdown measures in 2022, resulting in pent-up travel demand. However, the reopening of economies and COVID-19-related subsidies drove oil prices and inflation significantly higher.
Despite an uptick in sales growth, airline companies were struggling to improve profit margins. Further, to combat inflation, several central banks raised interest rates at an accelerated pace in the last 24 months. The airline sector is capital-intensive, resulting in a further erosion of the bottom line.
Lastly, the ongoing wars between Israel-Hamas and Russia-Ukraine, as well as the fiasco with Boeing’s lineup of 737 Max planes, might impact the airline industry in the near term.
Alternatively, the possibility of multiple interest rate cuts in 2024, a resilient global economy, and cooling inflation on the back of lower oil prices might drive airline stocks higher, given they trade at a cheap valuation.
Here are two undervalued airline stocks you can buy in February 2024.
Southwest Airlines stock
Valued at US$18 billion by market cap, Southwest Airlines (NYSE:LUV) stock is down 54% below all-time highs. Southwest Airlines reported adjusted net income of US$233 million or US$0.37 per share in the fourth quarter (Q4) of 2023. It ended 2023 with a net income of US$986 million or US$1.57 per share.
Southwest Airlines reported record revenue of US$6.8 billion in Q4, while sales stood at US$26.1 billion in 2023. After accounting for its balance sheet debt of US$8 billion, Southwest Airlines ended the year with US$12.5 billion in liquidity, providing it with the flexibility to navigate an uncertain macro environment.
In 2024, the company aims to optimize its route network to new demand patterns, which should contribute roughly US$1.5 billion in pre-tax profits in Q1. Due to this initiative, Southwest expects double-digit year-over-year revenue growth and operating margin expansion in 2024.
Analysts expect Southwest Airlines to increase sales by 6.5% to US$28 billion with adjusted earnings of US$1.51 per share. So, priced at 0.7 times forward sales and 20 times forward earnings, LUV stock is reasonably valued.
Air Canada stock
Air Canada (TSX:AC) was among the hottest stocks in the last decade, surging over 3,000% in the 10 years prior to the COVID-19 pandemic. Currently, down 64% below all-time highs, Air Canada stock is valued at a market cap of $6.5 billion.
Similar to other airline companies, Air Canada reported a strong operational performance in the holiday season, transporting close to 2.6 million passengers and completing 98% of scheduled flights.
In Q3 of 2023, Air Canada reported operating revenue of $6.34 billion, an increase of 19% year over year. Its operating income stood at $1.41 billion, indicating a margin of 22.3%, while adjusted earnings before interest, tax, depreciation, and amortization stood at $1.83 billion.
Air Canada ended Q3 with an operating cash flow of $408 million and free cash flow of $135 million, suggesting it allocated over $270 million towards capital expenditures.
Priced at 5.5 times forward earnings, Air Canada stock is really cheap and trades at a discount of 50% to consensus price target estimates.
