Have we seen a bottom in airline stocks? That’s debatable. On one hand, major names like American Airlines (NASDAQ:AAL) stock have fallen about 70% since February.
Even if things don’t completely “return to normal” after the novel coronavirus, shares could move significantly higher on an industry rebound.
On the other hand, big-time investors like Warren Buffett sold off their airline positions. Some have seen this as a sign that the airline industry’s prospects are getting worse, not better.
And now, with Boeing (NYSE:BA) CEO Dave Calhoun saying there could be an airline bankruptcy in 2020, there’s plenty of reason for investors to be fearful of legacy carriers like American right now.
The question is, will this airline be the one that goes bust? In prior analysis, I discussed how downside may be limited if shares fall down to single-digits. Yet, now I’m more skeptical of the carrier’s prospects in the coming year. Among the legacy carriers, it’s easy to see this one in particular having to file for Chapter 11.
So, what does this mean for investors looking at the stock today? Simply put, there’s plenty more downside from here. Granted, things could turn on a dime. Air travel rebounds quicker than anticipated, sending AAL stock significantly higher than it is right now. But chances are, investors will get more fearful, not less fearful, in the near-term.
Bankruptcy Risk and AAL Stock
How likely is it that American Airlines files for Chapter 11? Compared to major carriers, this airline seems the most likely to go bust. Legacy carriers like Delta Airlines (NYSE:DAL), as well as major low-cost names like Southwest Airlines (NYSE:LUV) are regarded as having the best balance sheets in the space.
American? Not so much. This may explain why the airline’s bonds are the costliest to insure. And looking at its balance sheet, that’s no mystery. As this Seeking Alpha contributor recently discussed, the company could have as much as $40 billion in debt by the end of the year.
Burning around $6 billion in cash this quarter, the airline is being kept afloat with the funds provided by the $2 trillion CARES stimulus bill. Without further government assistance, chances are AAL will need to file for Chapter 11.
Another bailout would help prevent AAL stock from heading to zero. But, even then, it’s tough to see shares moving higher from where they trade today. With the first bailout seen as too generous to airline shareholders, the U.S. Treasury will probably demand a greater amount of equity in a second round of relief.
In other words, dilution. That means your share of the overall business shrinks in size. Even if the company’s value improves, that minimizes the potential upside in your investment. Yet, dilution is better than wipe out. As it stands now, without a government bailout, your investment in AAL stock could potentially go to zero.
Are Shares Worth It at These Prices?
OK, so perhaps American is not a great buy at its current share price (just under $10 per share). But what if shares fall down to $5 per share? Or even lower, as some bearish price targets imply? In that scenario, perhaps the risk/return would make this a worthwhile opportunity.
It may be in the current administration’s interest to bailout the airline industry again. With a presidential election in November, a big-ticket bankruptcy making headlines would be terrible optics. This could mean struggling airlines like American get another lifeline, albeit in a highly dilutive transaction, as discussed above.
Yet, once the market prices in this dilution, shares could be a buy. As long as the company avoids Chapter 11, there could be substantial upside potential if the airline industry rebounds.
However, it’s debatable if the sector will rebound within a reasonable time frame. As I wrote in a recent article about Delta Airlines, it may take up to five years for air travel to recover. It’s possible Washington grants carriers another bailout, but they still wind up in Chapter 11 down the road!
In short, it’s tough to assess the potential risk return for this stock. Especially as a great deal of uncertainty remains in the airline sector.
The Bottom Line: Things Could Get Worse for AAL
AAL stock is heading towards single digits. In prior articles, I saw lower price levels as a strong entry point. But now, I’m much less certain. Given its weak balance sheet, and cash burn, bankruptcy looks like a high possibility. A second bailout could happen. But the dilution required for a second round of support may mean it’s not worth buying shares at today’s prices.
So, what’s the call? American shares may be a buy at much lower prices. Today? Not so much.
Thomas Niel, contributor to InvestorPlace, has written single-stock analysis since 2016. As of this writing, Thomas Niel did not hold a position in any of the aforementioned securities.
