UBS’ $100,000 phoenix autocall on Southwest Airlines offers rewarding but risky bet on recovery

By Emma Trincal

New York, Aug. 4 – UBS AG, London Branch’s $100,000 of trigger phoenix autocallable optimization securities due Aug. 3, 2022 linked to the common stock of Southwest Airlines Co. pay a high coupon in a straight single asset deal, without worst-of exposure. But the underlying stock implies higher risk due to the impact of Covid-19 on the airlines industry.

If Southwest Airlines stock closes at or above the trigger price – 60% of the initial share price – on a quarterly observation date, the issuer will pay a contingent coupon for that quarter at the rate of 19.74%, according to a 424B2 filing with the Securities and Exchange Commission; otherwise, no coupon will be paid that quarter.

If the shares close at or above the initial price on a quarterly observation date, the notes will be called at par plus the contingent coupon.

If the notes are not called and Southwest Airlines shares finish at or above the trigger price, the payout at maturity will be par plus the contingent coupon. Otherwise, investors will be exposed to the share price decline from the initial price.

Nice play

Tom Balcom, founder of 1650 Wealth Management, said the notes offer a good return opportunity for investors who are confident in the economy. The valuation of the stock and the barrier provided some level of comfort, he added.

“I like the coupon a lot. Even if you get called right away, it’s almost 5% in just three months,” he said.

“If you’re optimistic about the economic recovery, about things going back to normal and people starting to fly again, it’s a nice play.”

Balcom said he is hopeful the economy will recover soon.

“Once a vaccine, a treatment is being approved, airlines stocks will go up again,” he said.

The contingent downside protection allowing for a 40% decline in the stock price seemed sufficient given the current valuations, he added.

Discounted entry price

“The chances of hitting this barrier are small in my opinion,” he said.

The stock closed at $31.40 a share on Tuesday. It is down nearly 43% for the year due to a 62% drop from its February peak to its low in mid-May because of the lockdowns. Stay-at-home orders at the time caused the airlines to cut back flying. Since May, the stock has regained 40% but remains undervalued, trading 47% of its February high.

Southwest Airlines held up relatively well compared to its bigger competitors. American Airlines Group Inc. is down more than 60% for the year. Delta Air Lines Inc. lost 56% during that time.

Bullish on the economy

“Of course, you can’t completely rule out the downside risk,” he said.

“But you’re getting in at a bargain and you would have to lose an additional 40% to take a loss,” said Balcom.

“You’re much more likely to get called right away. No one is going to be upset at you for making 5% in three months.”

The pandemic has caused many airlines to virtually shut down. But Balcom sees the situation as temporary.

“I’m relatively optimistic about the economic recovery. We’ll find a coronavirus vaccine sooner than anticipated. Once we have that, a lot of industries like airlines, hotels, which have been devastated by Covid-19, will recover, and we should see a rebound.”

Hard to explain

Donald McCoy, financial adviser of Planners Financial Services, said he would not show the notes to his clients.

“I wouldn’t want to explain this type of note to a client. There are a lot of moving parts. It’s too complex,” he said.

The structure was also too risky, he added, pointing first to reinvestment risk.

“Is it going to be up or down in three months? You have no idea. You’re just flipping the coin.

“If it’s up, you get your 5% and you’re out. Now you have to do something with that money you went into trouble to invest.”

The notes would only be suitable for a limited number of clients, he said.

“It only makes sense if you’re bearish on Southwest Airlines, but you don’t think they’re going to get wiped out.

“You see the stock swimming along under water for two years,” he said.

Beaten up industry

McCoy said he prefers to get exposure to broadly diversified indexes.

“The note is not appealing at all especially since you’re dealing with one stock, which could be extremely volatile,” he noted.

“This is a sector of the economy that has been devastated. We don’t know if it is going to come back. There’s still a lot of risk.”

McCoy did not rule out the possibility of a barrier breach.

Unknown fundamentals

“Yes, you could see a 40% drop. The airlines industry has been fundamentally broken. No one knows when we will get back to where we were before the coronavirus crisis,” he said.

“It’s not just the airlines but every industry impacted by the pandemic like hotels, restaurants, cruise lines.

“If we have more lockdowns, the airlines may have to cut their seats by a third or even by half. How do you generate a profit in that case?

“We don’t know if their ability to make money will or will not be degraded permanently.

“There are many fundamental factors that remain unknown and haven’t necessarily been priced into these stocks.

“There is a lot of risk.”

UBS Financial Services Inc. and UBS Investment Bank are the underwriters.

The notes priced on July 31 and settled on Aug. 4.

The Cusip number is 90281N332.

The fee is 0.75%.

© 2015 Prospect News.
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