Airlines have been one of the hardest-hit industries in 2020 thanks to the novel coronavirus. American Airlines (NYSE:AAL) stock is down 61.4% year-to-date, and it’s not alone. Travel restrictions have banned many flights and brought the global travel industry to a screeching halt.
American Airlines stock is now trading at under $12 for the first time, which brings us to three three major questions for investors.
First, can the company survive Covid-19? Second, how much debt and dilution will it take to weather the storm? And third, will things ever get back to normal for airlines?
The News
At this point, I believe the first question seems to have been answered. Yes, American will survive Covid-19. The government has made clear it will support the airline industry with bailouts. Airlines are essential businesses, and they are all struggling. And I believe President Trump and his supporters would not appreciate the optics of a full government takeover of a major airline like American.
On April 14, American announced it received $5.8 billion in aid from the government. That aid included $4.1 billion via a direct grant and a $1.7 billion low-rate loan. American also said it anticipates obtaining a separate $4.75 billion loan from the Treasury.
As part of the terms of the bailout, airlines were on the hook for paying back just 30% of the grants. In other words, American just got $2.87 billion of no-strings-attached cash.
Which brings us to the second question. What will it take for American to survive the downturn? Delta Air Lines (NYSE: DAL) has said the government would be taking a 1% equity stake in the company as part of its bailout. Airlines are also banned from laying off workers before Sept. 30. They can’t pay dividends or buy back stock until Sept. 30, 2021.
American was forced to issue warrants as part of its bailout that could end up giving the Treasury a 6% ownership stake in the company. That dilution seems relatively small, but the key will be whether or not the current bailout is enough. Every time American needs more support, it takes on more debt and/or dilutes shareholders further.
The Outlook
The third question of if and when things will get back to normal is on the minds of all investors regardless of market sector. First of all, I do think things will eventually get back to normal. Sure, some things may change to prevent the type of hardships the world is enduring today. But people will always travel, and flying is the best way to travel long distances.
“Two factors driving our long-term outlook are low oil prices improving profit margins, with AAL’s fuel expense ratio falling from roughly 30% in 2012-14 to 16% in 2019; and long-term growth in air travel demand as the global economy integrates,” CFRA analyst Colin Scarola says.
CFRA has a cautious “hold” rating for AAL stock. But Scarola’s $26 price target suggests the stock could easily more than double from current levels over the next year.
In fact, prior to the Covid-19 disruption, U.S. airline passenger miles grew 4% annually from 2015 through 2019, according to CFRA. In other words, the airline industry was growing at twice the rate of overall U.S. GDP over the past five years.
How to Play AAL Stock
The airlines today remind me a lot of the banks back in 2008 and 2009. American now has more than $20 billion in long-term debt, a huge amount for a company with a market cap of just $4.7 billion. However, American also generated $3.79 in earnings per share in 2019. In other words, the stock is trading at a normalized earnings multiple of about 2.9, which is absurdly low.
Sure, it will probably be a long time before airline earnings get back to normal. But what is a long time? A year? Two? The stock market is forward looking, so however long it takes, investors won’t have to wait that long to see gains in the stock.
Those 2019 earnings demonstrate that, like the banks in 2009, airlines’ core businesses are solid. Once this unprecedented disruption passes, they will be solid again. Ironically, prior to the outbreak, I believed the big four U.S. airlines were positioned to stay profitable during the next U.S. recession for the first time in their history. Of course, nobody could have known the next U.S. recession would be triggered by a contagious virus that would completely shut down the travel industry like no other time in history.
In a nutshell, I think American and other airlines will survive the downturn with help from the government. I think their businesses and stocks will eventually recover. Personally, I prefer United Airlines (NYSE:UAL) over AAL stock because United has a larger market cap and lower debt levels.
Wayne Duggan has been a U.S. News & World Report Investing contributor since 2016 and is a staff writer at Benzinga, where he has written more than 7,000 articles. Mr. Duggan is the author of the book “Beating Wall Street With Common Sense,” which focuses on investing psychology and practical strategies to outperform the stock market. As of this writing, he was long UAL stock.
