Airline stocks like American Airlines (NASDAQ:AAL) have been wiped out in this selloff. Since Feb. 12, AAL stock has lost 62% of its value.
American is not alone. Among the four major U.S. airlines, Southwest Airlines (NYSE:LUV) is the “winner” over the stretch, with a 40% decline. Delta Air Lines (NYSE:DAL) has matched AAL’s drop. United Airlines (NASDAQ:UAL) has lost three-fourths of its value.
After those declines, some investors might believe the worst is priced in for AAL stock, and the sector. They should rethink that opinion. It absolutely can get worse. In fact, for American, another bankruptcy remains a potential outcome — in which case, the downside is another 100%.
On its own, it will at least take American many months, and likely several years, to convince the market its financial position is sound. In the meantime, AAL stock is going to trade on hopes that a savior is on the way.
Yes, American Can Go Bankrupt (Again)
At a conference last week, American tried to calm investor nerves about its financial position. The company disclosed that it has $7.3 billion in liquidity (cash on hand, plus short-term borrowing capacity). As American noted, that’s more than any other airline in the world.
But American also has much more debt than any of its fellow majors. Short- and long-term debt totaled over $24 billion at the end of 2019. The figure for Southwest is less than $3 billion.
As Barron’s noted last weekend, American’s debt load is the highest among U.S. carriers relative to underlying profits, too. This isn’t a case where American has more debt simply because it’s bigger.
That $7.3 billion might — emphasis on might — be enough to get American through what will be an enormously difficult 2020. American is offering voluntary leave to employees to cut costs. Fuel expenses will be dramatically lower for what flights still operate. American is going to lose money this year, but it might not lose $7 billion — or, more importantly, burn that much in cash.
The company is reportedly looking to raise more cash as well. Bloomberg reported this week that American is looking for a one-year credit facility in the “billions of dollars.” It would appear likely that the facility would be backed by assets, including what the company has said are over $10 billion worth of aircraft.
Still, the massive debt load means that just making it through 2020 isn’t enough. The company has another $3 billion of debt maturing in 2022 and 2023. If volumes stay low — driven by either persistent travel fears and/or a global recession — American is going to keep losing money. It can’t do so forever. It can’t even do so for all that long.
How That Plays on AAL Stock
And as long as those fears continue, AAL stock is not going to see a consistent rally. There will be bounces, to be sure: the stock already has had a few short-lived rallies during this long decline. But the stock still has a market capitalization of $6 billion. It’s not as if simply avoiding a near-term bankruptcy means its equity value will rise.
That aside, American’s reputation with investors has to be significantly tarnished at this point. This week, I highlighted the disastrous share repurchases made by Delta at past highs, using cash that instead should have gone to the balance sheet.
American has been far, far worse. As detailed in its Form 10-K filed with the U.S. Securities and Exchange Commission (p. 43), between July 2014 and the end of 2019, American spent $12.4 billion buying back its own stock.
That was a truly disastrous step. It was a step taken by a company that seemed to forget the history of the industry in which it operated. In a quote that will be infamous for years, chief executive officer Doug Parker even said in 2017, “I don’t think we’re ever going to lose money again … We have an industry that’s going to be profitable in good and bad times.”
That foolish optimism isn’t responsible for American’s current predicament. But it’s why American’s ability to respond is so limited. Instead of delivering the balance sheet, and de-risking its stock, American’s board of directors choose to buy back stock. That $12.4 billion certainly would come in handy right about now.
A Federal White Knight
And so AAL stock is in a sector that has been hammered — meaning investors have other choices that have seen similar, if not larger, selloffs. It has a management team and board of directors that has proven it can’t be trusted.
There is a case for nibbling at the sector given these declines, but even that case is difficult. Investors making that case will be hard-pressed to choose the most indebted, most dangerous stock among the four U.S. majors.
So what saves AAL stock?
It might be the federal government. The industry has asked for a $58 billion bailout, which may include airplane manufacturer Boeing (NYSE:BA) as well.
Hopes for that bailout may well drive trading in airline stocks over the coming weeks. It’s not just a matter of if the bailout comes. It’s on what terms. Do the likes of American get zero- or low-interest loans? Or is this a structure closer to that of General Motors (NYSE:GM), in which the federal government wound up becoming a significant shareholder?
For all the negativity I hold toward AAL stock, I can see the case for a trade in the name based on one assumption. If the terms are generous, the stock has the biggest potential for a rally. The reason why is the same reason for its decline: its leverage.
The Trade
Southwest is highly unlikely to go bankrupt, as it continues its history of savvy capital allocation. (It’s the only U.S. carrier to have avoided bankruptcy; American went bankrupt in 2011 and exited in late 2013.) And so a bailout would help LUV stock less than it would AAL stock. Bankruptcy risk isn’t priced into LUV, at least not to the same extent.
For American, however, a generous package could drive a huge rally. It would presumably take that near-term risk off the table, allow for breathing room and perhaps put a bottom under the stock. And given the Trump Administration’s clear focus on the U.S. stock market, such a package wouldn’t be a surprise.
A bailout doesn’t erase the long-term risks. It doesn’t excuse the disastrous decisions made by American management. But it could drive a short-term pop — and a big one. And so traders might want to consider AAL stock. The rest of us, however, should look to better operators with our hard-earned money.
After spending time at a retail brokerage, Vince Martin has covered the financial industry for close to a decade for InvestorPlace.com and other outlets. As of this writing, he did not hold a position in any of the aforementioned securities.
