When investors erased the year-to-date losses in the S&P 500 index last week, buying airline stocks like American Airlines (NASDAQ:AAL) did not seem like a risk. But AAL stock lost 10% of its value last week as markets decided it needed to price in novel coronavirus risks again.
The most likely near-term outlook for flight passenger growth is mixed. American may expect demand will not get beyond 25% of last year’s levels.
Zero Cash Burn Target Lifted AAL Stock
American’s stock rallied sharply on June 12 when the company targeted a zero cash burn rate by the end of this year. The company said that it “seeks to reduce its cash burn rate to approximately zero by the end of 2020 as expected demand conditions continue to improve and its cost initiatives continue to gain traction.”
American already cut its capacity by 75% in the second quarter. It forecast a disappointing 90% drop in revenue in the second quarter. But its liquidity will amount to around $11 billion as of June 30. That assumes it receives a secured CARES Act loan worth $4.75 billion.
High Near-Term Risks
Investors may have ignored the cash burn target date when they bid the stock higher. The zero cash burn rate is set for the end of this year. This implies that American will continue burning cash for the next six months. The airline did not detail any of its assumptions. For example, the recent trends of falling Covid-19 infections in the U.S. changed. Cases increased in many states in the last week and threatens to slow the economic re-opening.
In the filing, American posted the recent key data points. It wrote that “the table below summarizes recent domestic capacity, load factor, and customer data.”
(Year over Year)
|Down 70%||Down 75%||Down 70%||Down 45%|
|Passengers per Day||31,000||85,000||129,000||—|
* June load factor and passenger data MTD as of June 8
From SEC filing
The capacity did not change from April to the first eight days of June. In July, the company is forecasting a capacity improvement, down 45% compared to 70% in June. The passengers per day are growing steadily and suggest an acceleration in traffic throughout the summer.
American will likely cut staff levels in September, further lowering its operating costs. Plus, the recent 8% weekly drop in oil prices may help lower expenses, too. This will not amount to much savings but would still help. As its capacity grows, the company will save more and get closer to operating at a break-even rate.
On Wall Street, analysts turned bearish on American Airlines. Eight of the 14 analysts rank the stock as a “sell.”
|Savanthi Syth||Raymond James||Sell||—||Downgraded||8 days ago|
|Stephen Trent||Citigroup||Sell||$9||Reiterated||8 days ago|
|Jose Caiado||Credit Suisse||Sell||—||Reiterated||8 days ago|
|Jamie Baker||J.P. Morgan||Sell||—||Reiterated||9 days ago|
Data courtesy of Tipranks
Analysts are probably right this time: the bullish bet on American Airlines is too speculative. The company faces too many unknowns. Plus, the passenger traffic growth is not at a fast enough pace to offset the negative cash flow. With Covid-19 risks elevated again and tourism and business flight travel at low levels, this company will underperform.
Investors who want to model a more optimistic scenario may use a five-year discounted cash flow EBITDA exit model. This model allows you to forecast annual revenue growth. Use these metrics:
|Discount Rate||8% – 7%||7.5%|
|Terminal EBITDA Multiple||6.5 – 8.5||7.5|
|Fair Value||$3.29 – $31.87||$17.30|
Data courtesy of finbox.com
Investors may reasonably forecast a sharp drop in revenue this year. Revenue does not need to grow until the 2023 fiscal year. But unless revenue grows sharply after that, then the stock is already trading at close to its fair value.
Disclosure: As of this writing, the author did not hold a position in any of the aforementioned securities.