The novel coronavirus walloped nearly every sector in the U.S., but the crisis has taken a particularly brutal toll on American Airlines (NASDAQ:AAL) stock along with other airline companies. Share prices are down over 60% in six months.
But what’s more concerning are the broader implications Covid-19 will have for AAL and the industry.
Now, I get what you’re probably thinking; AAL has been here before, hasn’t it? In 2011, the company escaped insolvency when it merged into U.S. Airways, a narrow escape since it had filed for bankruptcy that very year. So, with the company getting $5.8 billion in taxpayers’ money to keep afloat, will things turn out the same as last time?
Probably not, since AAL is suffering from several long-standing issues that are unrelated to the present crisis. And, as you read on, you will get to know why I do not think that these issues will go away any time soon.
Bleak Outlook for AAL Stock
According to the International Air Transport Association (IATA), the U.S. airline industry will see a 55% year-over-year decline in passenger revenues for 2020, translating to $314 billion in lost revenue. In a previous report, the association said the worst-case scenario was that $113 billion would be lost.
Remember, these estimates are subject to revision and can change at any moment. But the general trend of these, and other reports, is negative.
The bottom line is that industry experts believe the situation is bleak, and it’s not getting any better soon. This is bad news for AAL.
A Lost Opportunity
This was supposed to be a groundbreaking one for AAL. In an earnings call in October 2019, CEO Doug Parker laid out a comprehensive plan for 2020.
After a couple of brutal years, Parker assured nervous investors that things were on the mend. He expected the company to generate $2.5 billion in free cash flow in 2020 and $3 billion in 2021. AAL would be using these reserves to pay down debt and finally provide some relief to long-suffering investors.
The markets rewarded the announcement, with AAL stock experiencing a healthy bump, but the euphoria was short-lived.
The coronavirus pandemic struck soon after, and although unprecedented, the crisis unearthed some interesting chinks in AAL’s armor that had gone unnoticed. One such interesting tidbit was the company’s insatiable appetite for share buybacks, even when free cash flow was in the docks.
Over the past five years, AAL spent $11.9 billion to repurchase shares, money meant to deleverage the balance sheet. It also led to a shoring up of earnings per share, an artificiality that has given way due to recent events.
Although all U.S. airlines have come under fire for these moves, AAL deserves a few more brickbats than others. Over the last five years, capital expenditure outstripped operating cash flow by a considerable mile each year. Parker said the company was taking advantage of low-interest loans. Oil prices were low, margins were high, and the company would likely ride out any bad years.
Sadly, it wasn’t a prudent strategy as time has shown. And if the company didn’t revenue bailout money from the U.S. government, some serious questions were arising regarding its solvency.
It’s Crunch Time for AAL Stock
What’s frustrating to see with AAL stock is the lost potential more than anything else. The company was logging some respectable operating margins, and that’s why it’s frustrating where the company finds itself. Liquidity is going to be a big issue looking ahead, a fact illustrated by its quick ratio of 0.28 in the latest quarter — a worrying figure.
Long-term debt is also particularly problematic, as it’s been consistently rising for the last five years. Government grants will sustain the company for a while, but no amount of bailout can cover for bad decisions. Long-term debt has skyrocketed over the past five years, and interest expenses are now taking $1 billion annually out of the balance sheet, a worrying sign by all accounts.
Painful Decisions
The airline industry has a problem, and labor costs are at the heart of the issue. In 2019, data showed that labor expenses represented 28% of U.S. airlines’ $187 billion in revenue over the last year. It’s the same situation when you look at American Airlines, where labor costs dominate operational expenses.
In its recent quarterly earnings release, the company did comment on how it was decreasing labor costs through slashing executive and board compensation and suspending all nonessential hiring, among other things. The initiatives will help save over $12 billion in 2020.
One thing to note will be how employees will handle this decision. The airline industry is highly unionized, with between 80% and 85% of AAL workers in a union. The influence of these unions was on full display when they recently succeeded in negotiating protections as part of the overall bailout package.
While having these unions in place is not always bad for business, it’s notable that AAL management and trade union bodies have been at loggerheads in the past, with the former suing associations that also have their employees as members. If there are issues that adversely affect employees, these unions could also initiate legal proceedings that could stall necessary cost-cutting measures.
Throwing In the Towel
Warren Buffett is an optimist at heart. That’s why it came as a surprise when the billionaire investor chose to exit his stakes in American Airlines, Delta Air Lines (NYSE:DAL), Southwest Airlines (NYSE:LUV), and United Airlines Holdings (NASDAQ:UAL).
This means Berkshire Hathaway (NYSE:BRK.A, NYSE:BRK.B) has washed its hands of the airline industry. Share prices for the companies fell as a result of the move, and this is hardly surprising. Any investor worth his or her salt looks at Buffett as a trendsetter for the industry.
If he sells, so do a lot of people, and investor interest is likely to sour as a result of his exiting positions in these airlines.
The Bottom Line for AAL Stock
Analyst predictions point to there being a 26.2% upside to AAL’s current valuation of $10.14. Even if the share price climbs to $12.80 in one year, there’s still a lot of unpredictability in the air. Revenues are estimated to take a 52.4% hit this year.
It’s tough to recommend shareholders load up on AAL stock when the outlook is this bleak. Even if the company manages its way out of the woods, long-term headwinds will haunt it for the foreseeable future.
It will be a long time before people are comfortable flying again, and that’s why it’s a good time for you to let AAL fly solo for a while.
