American Airlines (NASDAQ:AAL) just reported a first-quarter loss of $2.2 billion, but faces even more severe losses in Q2. The company is in deep financial trouble and as a result, AAL stock is likely to face further downside. It seems prudent that most investors should stay away from this stock for the time being.
For example, American Airlines experienced a decline of 18.9% in its mainline revenue passenger miles during Q1. Flights were reasonably full for at least half of the quarter until coronavirus-related lockdown measures were put in place in mid-March. But that still led to a huge loss in Q1.
However, during Q2 passenger traffic is down over 90% or higher for most airlines. The Wall Street Journal says that the number of people passing through security is down 95% from a year ago. That translates into a 95% collapse in revenue passenger miles for much of Q2 for most airlines.
The silver lining is that the number seems to be picking up each day. That bodes well for a pickup in revenue passenger miles from a decline of 90%-plus in April.
American Airlines’ Cash Flow Losses Will Skyrocket
American Airlines says its net loss was only $1.1 billion before special write-downs that it claims are not cash write-downs. Eventually, some of these items could lead to penalties that American Airlines has to fork out, like canceling leases.
During Q1 American Airlines burnt through $1.013 billion in free cash flow losses. The company said in its April 30 press release that its Q2 estimated cash burn rate is $70 million per day. That amounts to a significant increase in FCF losses of $6.37 billion (91 days x $70 million).
However, for the month of June, the company expects to be burning just $50 million per day. That means that April’s cash flow losses are significantly more than $70 million per day. This is because the average for all of Q2 is expected to be $70 million. If the month of June has $50 million in daily burn rate, that means that April and May are likely to be higher than $70 million.
And remember, this assumes that by June passenger traffic picks up significantly. The company did not say what it expects to see in terms of revenue passenger miles. Nor did it indicate what kind of downdraft in terms of percentage year-over-year it expects to see in Q2 or June.
AAL Stock Liquidity Is Alarming
American Airlines cannot afford to burn through another $6.37 billion in cash in Q2. For example, at the end of March, it had just $3.57 billion in cash and securities on its balance sheet. That means the company will have to borrow even more money just to get through the quarter.
Here is how American Airlines couches that quandary. Their “liquidity” will increase to $11 billion by the end of Q2.
What does that mean? Does that include the estimated cash drawdown of $2.8 billion (i.e., cash burn of $6.37 billion less $3.57 billion in cash available at the end of March)? What about the cash-flow deficit expected in Q2? Does that $11 billion include any cash writedowns?
Moreover, will $11 billion be enough debt to get through the cash flow losses expected from Q2 all the way to the end of the year? There is almost no way to predict this right now.
In addition, American Airlines already has over $25 billion in short-term and long-term debt. This does not include $15.7 billion in other current liabilities as well as $20.4 billion in other non-current liabilities. For example, it has a $6.1 pension liability on its balance sheet.
Possibility of Insolvency Not Out of the Question
Right now American Airlines has had so many losses that its shareholders’ equity is significantly negative. On March 31, its book value was negative $2.636 billion. This works out to negative $6.23 per share ($2.636 billion divided by 422.894 million shares outstanding).
If the company were to post another $11 billion in losses by using up all its estimated liquidity, shareholders’ equity could collapse to negative $13.6 billion or higher. That is equal to negative $32.24 in book value per share. In fact, it could be worse on a per-share fully diluted basis if the company has agreed to provide warrants or equity shares to any of its lenders.
So why is AAL stock still trading for $4.5 billion in market value? That is what the market is at a price of $10.64 per share. This market valuation seems completely out of whack for the realities of American Airlines’ solvency question.
There are two generally accepted views of insolvency. The first is where debt so massively overwhelms a company’s assets that it is not going to turn a profit anytime soon. The second view of insolvency is where the company can no longer pay its bills.
Clearly, American Airlines fits the first definition of insolvency. But you will never know when or if it hits the second definition. By that time, the company will decide to reorganize under Chapter 11 to prevent any creditors from attaching their collateral assets. It will happen out-of-the-blue.
What to Do With AAL Stock?
Warren Buffett just announced he sold all of the airline stock holdings at Berkshire Hathaway (NYSE:BRK.A, NYSE:BRK.B). He also admitted he made a mistake by investing in these companies, including American Airlines.
He gave two major reasons. One is the company may end up with too many airplanes if consumers don’t return quickly to airline travel. The second reason is that the companies will need to increase their debt considerably, hurting future earnings as they pay it off.
Buffett hates companies with lots of debt. That is exactly where American Airlines will be by the end of this quarter. He was willing to take a loss of over $1.5 billion in his holdings.
What does that tell you? He wanted to preserve his capital. Buffett likely estimates that the valuations of these companies will be significantly lower after he sold them.
I recommend you consider doing the same with AAL stock. It is highly likely to be much lower in the next several quarters as its losses and debts pile up.
As of this writing, Mark Hake, CFA does not hold a position in any of the aforementioned securities. Mark Hake runs the Total Yield Value Guide, which you can review here.
