Airline stocks have been hammered, which is no surprise under the circumstances. The coronavirus from China dealt a painful blow to the stock market, and the airlines industry in particular. American Airlines (NASDAQ:AAL) hasn’t been an exception to that pain, with AAL stock down about 50% this month.
However, some analysts believe even more pain could be in store. Analysts at Bank of America slapped a $5 price target on American Airlines on Monday morning. After closing north of $10 on Friday, that implies more than 50% downside in the stock price.
Keep in mind, AAL stock has already fallen roughly 60% from its one-year high. That’s better than the 70% tumble in United Airlines (NASDAQ:UAL). However, it trails Southwest Airlines (NYSE:LUV), which is down 38% from its one-year high.
Uncertainty and Disdain
On the one hand, it’s hard to imagine the federal government letting the airline industry go belly up. That includes suppliers like Boeing (NYSE:BA) and General Electric (NYSE:GE), too.
There are simply too many jobs on the line and air travel is a major piece of domestic and international logistics. That being said, Congress has yet to pass any financial relief along to the industry, even though it’s under incredible financial strain.
However, there’s a certain amount of disdain toward the industry.
People are frustrated that airlines have spent billions of dollars in shares buybacks and are now requesting what is essentially a bailout. Some reports have said 96% of the industry’s free cash flow has gone toward corporate buybacks, helping to inflate earnings per share instead of building up a war chest of capital in the event of tough times. Others say Warren Buffett’s Berkshire Hathaway (NYSE:BRK.A, NYSE:BRK.B) should bail them out. Berkshire is one of the largest shareholders in the industry and is flush with cash.
The whole thing has left investors and observers torn on whether the industry — which now appears careless at best and selfish at worst — really deserves a bailout. The flip side of that is, was it really irresponsible to buy back stock? No one was predicting that the global economy would slam on the brakes due to a worldwide pandemic.
The companies have already signaled to Congress that layoffs are around the corner without aid. That’s no surprise, with Delta Air Lines’ (NYSE:DAL) management saying it’s burning through about $350 million a week at the moment.
All we know now is that the situation is loaded with unknowns. We don’t know if or when the government will step in and to what extent they plan to help.
AAL Stock to $5?
Distressed stocks are a tough one for investors to figure out. Mostly because balance sheet analysis is not the forte of the casual investor. In the case of AAL stock, the company held $3.8 billion worth of cash and short-term investments as of its quarter ending Dec. 31.
We also know that it had current assets of $8.2 billion and current liabilities of $18.3 billion.
That initially raises a red flag on whether American Airlines has the reserves to cover its short-term obligations. A bulk of its current liabilities is in deferred revenue — essentially sales from customers that have not yet received their service (flight). While customers may press for a refund, they are likely to only get credits for future travel.
It doesn’t help that American Airlines hasn’t been free cash flow (FCF) positive for the past three years. Or that this immediate slowdown comes during the first quarter, which is almost always the company’s strongest season of free cash flow. Equally painful is the revenue loss AAL stock will experience in Q2, which is the company’s strongest quarter of sales. The third quarter will likely suffer too, which is American’s second-best quarter of sales.
It doesn’t take a rocket scientist to compute the following: Crimping free cash flow during its best FCF period, plus negatively impacted sales during its two best revenue quarters, plus balance sheet concerns, plus several unknowns relating to federal aid.
So far, that equation has worked out to “sell.”
I don’t know whether $5 is in the cards for AAL stock or not. I do know that the airline industry will exist when this is all said and done, but I don’t know what structural changes lurk around the corner.
All I know is that there are too many unknowns with this one for me to be a buyer.
Bret Kenwell is the manager and author of Future Blue Chips and is on Twitter @BretKenwell. As of this writing, Bret Kenwell did not hold a position in any of the aforementioned securities.
