A tug of war is brewing between the airline bulls and bears. Ever since the novel coronavirus outbreak sent airline traffic lower, shares of American Airlines (NASDAQ:AAL) hammered down to the $10 level. Buyers tried to send AAL stock back by 30%-50%. But optimism continues to wane as markets evaluate the sector’s prospects.
AAL stock will more likely suit traders. Why? For starters, legendary investor Warren Buffet sold his entire stake in airline stocks.
Buffett revealed that his Berkshire Hathaway (NYSE:BRK.A, NYSE:BRK.B) dump all airline stocks from its portfolio. He said that he was wrong about the business. When he started a position in American and United Airlines (NASDAQ:UAL), he thought that he bought the business at an attractive price. But the Covid-19 pandemic forced countries to close their borders to foreigners. Domestic and international business travel fell to practically zero (down more than 90% from last year). And tourism is not on anyone’s near-term plans, either. [Which, see: Carnival Corporation (NYSE:CCL), Royal Caribbean Cruises (NYSE:RCL)]
Dallas-based American is managing costs and watching its cash flow drain day by day. It cannot predict passenger miles volumes. For now, the market is content with a $4.84 billion market cap at the $10 a share price. That reflects the 18.9% drop in revenue passenger miles in the first quarter. Its load factor fell from 83.1% last year to 73.9%.
High Cash Burn
The second quarter will include more weeks of the lockdown. American ended Q1 with $6.8 billion in liquidity, which included $2 billion generated in the period. Management forecasts a $70 million daily cash burn rate for the current (second) quarter. In June, the burn rate will fall to $50 million a day.
Industry trade group Airlines for America in a prepared Senate testimony last week that U.S. airlines are allegedly losing $10 billion a month. The sector already grounded half of the U.S. fleet. At 17 passengers per domestic flight, the business is not sustainable without government help. The Treasury’s $25 billion of cash grants to airlines will sustain the paycheck of airline employees until Sept. 30. But until the U.S. fully contains the virus, flight bookings will not increase in the near-term.
When the commitment to not furlough employees through Sept. 30 ends, airlines will get smaller paychecks. Fewer hourly workers will obviously lower American’s costs.
Protecting Staff and Passengers
On May 4, a number of airlines began requiring passengers to wear a face mask while traveling. American followed with the same requirement in an announcement a week later. Representatives said that “this new requirement is part of the airline’s ongoing commitment to prioritizing customer and team member well-being in response to the coronavirus pandemic.”
The more safety procedures put in place at airlines, the less likely that anyone gets infected by the virus. As the pandemic crests and falls sharply, this will ultimately accelerate the demand rebound in air travel.
Valuation and Your Takeaway
American stock has a fair value of $18.05, implying a margin of safety of 78%. The stock suffers from a low sentiment score compared to the S&P 500 index:
Data courtesy of Stock Rover
Screening against Southwest Airlines (NYSE:LUV), Spirit Airlines (NYSE:SAVE) and UAL, American scores the lowest. Still, on Wall Street, the average price target on American stock is $13.82 but more analysts rank the stock as a sell than as a buy. (To get updated scores in real-time, download this text file and import it into Stock Rover.)
For now, American Airlines is a gamble for speculators. Value investors should wait for more evidence that airline traffic is improving at a sharp pace. Until then, add airline stocks to a watch list for future investing.
Chris Lau, contributing author for InvestorPlace.com and numerous other financial sites. Chris has over 20 years of investing experience in the stock market and runs the Do-It-Yourself Value Investing Marketplace on Seeking Alpha. He shares his stock picks so readers get original insight that helps improve investment returns. As of this writing, he did not hold a position in any of the aforementioned securities.