What’s the play with American Airlines (NASDAQ:AAL) stock? Down more than 50% in a month, shares could be a great contrarian buy. Especially if the economic fallout from the coronavirus from China proves less dire than predicted.
Yet the outbreak only added to the airline’s existing issues. Borrowing money to finance buybacks, the airline played it fast and loose.
That worked while the economy was firing on all cylinders. But with air travel effectively halted and the company hemorrhaging cash, it’s hard to see this story end in anything but tears for investors.
However, there’s light at the end of the tunnel. A government bailout of the airline industry could prevent bankruptcy. But with high uncertainty and minimal upside, it’s tough to find a compelling reason to buy AAL stock at today’s price levels, around $15 per share.
So should you go short American Airlines stock? Or do you wait for a more promising entry point and lay down your chips? Let’s dive in and render a verdict for this moribund airline.
AAL Stock and COVID-19
The coronavirus from China (COVID-19) could send scores of companies into Chapter 11. This includes restaurants, retailers, casinos, cruise lines, along with airlines. A capital-intensive, highly-leveraged industry, airlines are ill-equipped to handle black swan events like this outbreak.
The airline industry’s behavior also doesn’t give them much sympathy. Customers resent the industry’s nickel-and-dime tactics in order to maximize profits. And another major industry trend has brought challenges to them, as they come to Washington, hat-in-hand, for a bailout.
What I’m talking about are stock buybacks. As InvestorPlace’s Bret Kenwell discussed March 24, nearly all of the industry’s free cash flow has gone to buybacks in recent years. American Airlines is no exception. As this Seeking Alpha contributor recently wrote, the airline overextended itself borrowing money to buy back shares. It’s up for debate whether bailing out companies that spent their safety net on buybacks is right or wrong. But with the U.S. Senate passing a stimulus bill, an airline bailout is on the table.
Yet does federal intervention equal big upside for AAL stock? The bill includes $25 billion in loan and loan guarantees for passenger airlines. Yet American Airlines alone has $24.3 billion in debt and finance leases. In other words, it may not be enough to shore up the whole industry.
This bill could ensure the airline doesn’t go bankrupt. But that doesn’t mean shares won’t fall further, if unprofitability continues and the company must borrow more due to cash outflows, further downside appears more likely.
Stimulus May Not Be Enough To Send Shares Higher
In recent days, AAL stock has rebounded from its 52-week low around $10 per share, up to above $15 per share. A passed stimulus package could bring further upside. But there are several factors to consider. Firstly, if the airline accepts any of the loans/loan guarantees offered by the bill, they would be unable to pay out dividends or buy back stock for one year after the loans were repaid.
But more importantly, does this bill change the current environment for American Airlines? According to the New York Times, with coronavirus bringing travel to a halt, only a handful of passengers are riding the airline’s typically busy routes, like New York to Los Angeles. And with most of its international routes grounded, they have little money coming into their coffers.
Until things get back to normal, it’s hard to predict upside potential in AAL stock. All bets are off whether “normal” happens a few weeks from now, or a few months from now. So, with this uncertainty, how do we handicap this stock?
That’s the issue. It’s tough to put a number how much coronavirus will set American Airlines back. Also, there’s no guarantee the airline’s volume immediately returns back to 100%. What if their passenger volume only goes back to, say, 80% of where it was?
Too Late To Short, Too Early To Buy AAL Stock
The opportunity to short AAL stock has come and gone. Investors shrewd enough to sell short as the outbreak first made headlines back in January realized big profits. But investors who try to ride it down to zero today could get more than they bargained for. Going short this name, if the end of coronavirus lockdowns is around the corner, could result in an epic squeeze.
Yet, we may be far from the bottom. Shares have rebounded in recent days as the stimulus bill advances in Congress. But, this could be a dead cat bounce in hindsight. With the risk it takes years for the airline to get back to where it was, buying at $15 for it to rally back to $30 looks like a bad proposition.
So, what’s the play? Wait things out with AAL stock. The risk/return at $15 per share doesn’t look worthwhile.
Thomas Niel, contributor to InvestorPlace, has been writing single-stock analysis for web-based publications since 2016. As of this writing, Thomas Niel did not hold a position in any of the aforementioned securities.