American Airlines Bonds Warn of Severe Downside Risk for AAL Stock

American Airlines (NASDAQ:AAL) was a high-flier over the past month. Shares doubled, and briefly topped $20 at one point earlier in June. However, it’s quickly cooling back off; AAL stock has dropped 20% off recent highs and is in danger of breaching technical support in the coming days.

American Airlines Bonds Warn of Severe Downside Risk for AAL Stock

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It’s not hard to see why. American Airlines traded up as part of a broader wave thanks to the reopening trade. With the economy coming back online, virtually all travel stocks soared.

Now, however, we’re seeing numerous closures and setbacks as the novel coronavirus continues to wreak havoc. Investors will take a closer look at individual travel names and separate the quality ones from the weaker names. In doing so, American Airlines will be one of the losers.

Sentiment, Data and AAL Stock

Since the airline sector bottomed in early May, the airlines have put in similar performances. The sector exchange-traded fund, the U.S. Global Jets ETF (NYSEARCA:JETS) is up 45%. Southwest (NYSE:LUV), Delta (NYSE:DAL), and JetBlue (NASDAQ:JBLU) are all up between 45% and 50% as well. American has gained 70%, and United (NASDAQ:UAL) leads the pack at +75%.

As you can see, however, there’s not much difference between the bunch. Traders are buying indiscriminately rather than trying to pick out between the better and worse operations. And that’s fine as a purely technical operation following a steep dive.

However, when investors start sorting through the various airlines individually rather than buying and selling the sector as a basket, they’ll see that American remains on shaky footing compared to its rivals.

American Airline Bonds: No Comeback Here

For all the excitement around American Airlines stock, the bonds aren’t showing much sign of life. A benchmark 2022 maturity date American Airlines bond that pays 5% annual interest is currently trading at 71 cents on the dollar.  At this price, it yields more than 24% annually if you hold to maturity and the company pays it off in whole at that time.

Notably, these bonds traded at 70 cents on the dollar on March 23, when the stock market as a whole bottomed. Since then, American’s bonds are barely flat, even while stocks in general have soared. Thus, equity traders are buying into the idea of a huge economic comeback while the credit market is saying that very little has actually changed.

And, realistically, how much do people buying American Airlines stock think they’re going to make? If American merely avoids bankruptcy for two years, the bonds will produce a 24%/year return. Even if American goes into bankruptcy, the bonds would likely retain much of their value while the AAL common stock is wiped out. 24%/year returns are great in any environment and particularly so now.

The fact that American’s bonds pay that high of a yield shows the off-the-charts level of risk that the company still faces. To that end, look at American recently announcing that it intends to be cash flow neutral by the end of the year. For one, that’s an ambitious goal that they will likely struggle to achieve. And two, when you’re deep in debt, merely avoiding further cash burn is hardly enough to salvage the situation.

AAL Stock Verdict

I understand the appeal of wanting to own an investment that will recover as people start vacationing again. The reopening trade has been a great one, and many of the companies that are soaring could turn into huge long-term winners in future years.

But American Airlines is just about the worst possible way to express this trade. American is drowning in debt, and even with the recovery elsewhere, it’s far from certain that American will even stave off bankruptcy, let alone soar back to previous heights.

Instead of American, you could own an airline with a far stronger balance sheet like Southwest or JetBlue.

You could own a nearly debt-free airport operator such as Monterrey, Mexico’s Grupo Aeroportuario del Centro Norte (NASDAQ:OMAB). Or you could go with an airline ticketing software company such as Sabre (NASDAQ:SABR).

Then there’s airplane parts, hotels, casinos, and more — there are so many ways to invest in travel. Why go with one of the most embattled and indebted operators out there? American Airlines stock offers way more risk than reward at this point.

Ian Bezek has written more than 1,000 articles for InvestorPlace.com and Seeking Alpha. He also worked as a Junior Analyst for Kerrisdale Capital, a $300 million New York City-based hedge fund. You can reach him on Twitter at @irbezek. At the time of this writing, he held a short position in AAL stock. He also owned OMAB and SABR stock.


Article printed from InvestorPlace Media, https://investorplace.com/2020/06/american-airlines-bonds-warn-of-severe-downside-aal-stock/.

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