Description

Thesis 

Airlines are shitcos...  But they are shitcos that have been acting more rational, are about to enter a supply shortage, and the market still views them as the ultimate shitcos, trading at 5x street earnings.  They are about to fly.  If the stars align, they may even exit the stratosphere, because everyone’s acting more rational, and there’s a supply shortage.

“’Railroads are no damn good, too many of them, truck competition.’ We were right — it was a terrible business for about 80 years. Finally, they got down to four big railroads, and it’s a better business. Something similar is happening in the airline business.”

- Charlie Munger, 2017 Daily Journal Meeting

Overview

To my knowledge, the airlines have never had a supply shortage.  Maybe the Wright brothers could have needed two planes instead of one, but aside from that, this industry has suffered from overcapacity… until now.  

Boeing has not gotten its shit together in over 5 years – and the clock is still going.  When you’re supposed to be building 800+ planes a year, and you produce an average of ~400 for six straight years, you create supply problems for airlines.  When you throw Airbus in the mix, who’s also supposed to be producing 800+ planes a year and is stuck at ~700, you have more supply problems for those airlines.  When you add in an engine maker who (oops!) makes engines for three years before it realizes there was defective metal powder in those engines causing cracks in the engines and forces planes to stay on the ground longer and delay deliveries of the new models of those planes, you compound that problem.  We estimate the industry has been ~4,000 planes (15% of the global fleet) over the past several years and will be increasingly short planes as demand continues to recover.

At current build rates, every day that Boeing’s strike goes on, another 737MAX doesn’t get built, and we’re on day 15 of the strike.

We have followed the metal melters, the forgings and castings players, the component providers, and we are short across the supply chain…

We are short engine metal, as evidenced by CRS’ sales per pound.

We are short engines, as a result of the metal shortages, as evidenced by GE’s record high B/B 

With no new engines, we have no new planes, so to meet demand, we are seeing airlines return previously parked planes to the active fleet, as evidenced by the extended fleet ages

Narrowbody Average Age

Widebody Average Age

But after keeping planes in service as long as possible, we’ll be even shorter MRO capacity for years to come, further capping the lever of fleet life extension

And companies that own planes (i.e. lessors) are seeing massive increases in lease rates and gains on sale of their planes

Which is pressuring margins of carriers who primarily lease (i.e. ULCCs).  ULCCs extrapolated pre-COVID demand trends, expected a faster snap-back and locked themselves into high-cost leases, changing the paradigm of the industry

These issues support a far-more-consolidated market to be that much more rational… as evidenced by a previously aggressive grower (Southwest) who now has a stated campaign to undergrow the industry and become more profitable (…and an activist to ensure they do it) 

ULCCs have also effectively cut capacity to manage their cash flow by selling their delivery slots from the OEMs.

On top of these supply issues, we have the Geared Turbo Fan (GTF) issue from Pratt and Whitney (P&W).  P&W had cracking in metal powder found in compressor and turbine disks due to a quality control issue with powder metal used to make engine components inside the core.

“The magnitude and multitude of availability challenges we are experiencing with the GTF engine are something we are working hard to mitigate. But they continue to have a significant impact on our business and on our long-term planning ability. In addition to powder metal-related inspections, challenging our engine availability, we've experienced a number of other unscheduled engine maintenance visits that are resulting in GTF engines coming off wing much sooner than anticipated, some after just a year of flying.” (JBLU)

• This issue is causing material issues for ULCCs like Spirit who are focused on the Airbus A320neos which use the GTF engines and are experiencing grounded planes (AOGs) as a result

  • “The time to take an engine off wing and get it all the way through a heavy visit and back on wing is north of 400 days. And that's why the worldwide system is backed up and why you're seeing us, for example, expecting north of 60 AOGs next year. There's simply not enough spares in the system and there's not enough throughput yet on the MRO side.” (SAVE)

  • “A majority of the 11 average aircraft grounded this year are due to inspections outside of powder metal.  Based on the latest numbers provided by Pratt & Whitney, we are now expecting the average number of grounded aircraft in 2025 to be in the mid- to high teens with greater uncertainty in 2026 and beyond. This will drive roughly flat year-over-year capacity in 2025. In order to reach flat growth, we'll need to continue investing to extend the lives of our A320 fleet.” (JBLU)

  • “Industry capacity has moderated significantly over the past year, and we at Southwest are doing our part to reduce capacity in line with those demand trends. Our capacity will be down year-over-year in the fourth quarter, and we have committed to grow at or below economic growth rates of flat to 3% until we cover our cost of capital. But now I expect annual capacity growth in 2025, 2026 and 2027 to be in the 1% to 2% range. In addition to our own growth targets, we expect production issues at Boeing and issues related to the geared turbofan to continue to act as a constraint on industry growth for years to come.” (LUV)

Between the slow turnaround times (250-300 days), shortages in upstream materials and the OE deliveries, we expect the GTF issues to get worse, not better, over the next 2 years and take out an additional 600 planes from service.

Demand

This supply shortage is in the context of demand that historically grew MSD% 

And is now nearly 25% below trend demand as countries reopened from COVID at different rates (i.e. China later than US).

As global demand has continued to recover, global load factors have increased to historical highs and it appears that we have hit a point where we have pulled every parked plane out of storage that we can.  

There are other nuances to the thesis (value of loyalty programs, likely exit of irrational competitors via bankruptcies that result in industry consolidation), however, the supply/demand dynamic seems to be massively underappreciated.

Valuation

If UAL comes close to their 2026 guidance in 2027, we can pencil out #s $12B+ of EBITDA, well above Street #s.  UAL’s 2026 guide assumed (1)% RASM growth vs. 2019 and fuel prices 10% above where they are currently.   

UAL also has $15B of cash on the balance sheet, and recent commentary suggested they are going to begin repurchasing stock.  We see a path to $20+ of EPS in 2027, creating the stock at <3x EPS.  

During the last airline upcycle, UAL traded north of 8-10x earnings, which we think is more than reasonable.  As a result, we see a path for UAL to triple over the next 2 years.

Catalyst

DAL investor day

Earnings

Capacity schedules