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Debt Will Keep American Airlines Stock Prices Depressed

The airline industry revenue has collapsed due to the novel coronavirus pandemic. While I am positive on a few names in the industry, American Airlines (NASDAQ:AAL) is one company I would avoid. AAL stock has plummeted by 72% from 52-week highs and currently trades at $9.65. Even after this big downside, the stock remains unattractive.

American Airlines Could Crash, But Is It the Only One?

Source: GagliardiPhotography / Shutterstock.com

Recently, Boeing (NYSE:BA) CEO David Calhoun predicted that at least one airline is likely to go bankrupt during the current crisis.

Barron’s subsequently published an article on the likelihood of bankruptcy for major airlines.

The article notes that the credit default swaps for Southwest Airlines (NYSE:LUV) and Delta Airlines (NYSE:DAL) are trading at a spread of 4.7% and 12% respectively. On the other hand, the CDS for American Airlines and United Airlines (NASDAQ:UAL) trades at a spread of 54% and 24% respectively.

Clearly, the CDS indicates that investors are nervous about the company’s debt repayment ability. Even without looking at the CDS, the balance sheet of American Airlines is stressed as compared to peers. I am not suggesting that American Airlines is headed for bankruptcy. My only point is that relative to peers, AAL stock is not worth considering.

The Positives and Challenges

American Airlines is positioned to navigate the next few quarters with ample liquidity buffer. For the first quarter of 2020, the company reported total liquidity of $6.8 billion. With over $10.6 billion of financial assistance expected from the government, the company has nearly $17 billion in liquidity.

Further, American Airlines has also identified unencumbered assets worth $10 billion. Pledging these assets can help the company raise additional loan in the coming quarters.

However, the company is expecting a daily cash burn of $50 million per day from June 2020. This would imply a quarterly cash burn of $4.5 billion. At the end of Q2 2020, the company expects to have a lower cash buffer of $11 billion. Therefore, if passenger traffic remains weak through fiscal year 2020, American Airlines will end up with significantly higher debt.

Delta Airlines CEO Ed Bastian opines that it will take two to three years for the industry to recover from the crisis. If this assumption holds true, AAL stock should be avoided. Even if the company escapes bankruptcy, there will a huge debt burden and potentially scaled down operations.

Additionally, Dr Anthony Fauci has already warned of serious consequences if the economy reopens too soon. It might therefore be too early to conclude that passenger traffic levels can improve consistently in the coming quarters. A second wave of the novel coronavirus can imply bigger trouble for the industry, particularly for overleveraged companies such as American Airlines.

Overall, the liquidity buffer is the only positive. If there is a prolonged cash burn, credit stress will increase and AAL stock will trend lower.

My Final Views on AAL Stock

In any crisis, the biggest investment opportunities come from the hardest hit sectors. Valuations become a function of fear and panic than fundamentals and long-term business outlook. But at the same time, new leaders can emerge after upheaval and larger companies can shrink or go bankrupt.

From the current year to FY2022, American Airlines has total contractual cash obligations of $34.3 billion. That includes debt repayment, capital expenditure, lease obligations and interest obligations, among others. I expect the debt servicing cost to increase as debt is refinanced during these years. Further, other cash obligations will continue to put pressure on the company’s balance sheet.

Looking back, American Airlines used $12.5 billion of free cash flow between FY2010 and FY2019 to buyback shares. The company’s balance sheet would have been in better shape if this cash would have been used for deleveraging.

For now, the company is focused on survival, with too many uncertainties on the road to recovery. In this scenario, it does not make sense to consider exposure to AAL stock. There are companies with a better balance sheet in the industry which are better-positioned to navigate the crisis.

Faisal Humayun is a senior research analyst with 12 years of industry experience in the field of credit research, equity research and financial modeling. Faisal has authored over 1,500 stock-specific articles with a focus on the technology, energy and commodities sector. As of this writing, he did not hold a position in any of the aforementioned securities.


Article printed from InvestorPlace Media, https://investorplace.com/2020/05/debt-will-keep-american-airlines-stock-prices-depressed/.

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