Airline stocks are surging off March lows after an uptick in demand for air travel as the U.S., and other countries have started to ease lockdown restrictions. American Airlines (NASDAQ:AAL) announced that it was resuming a sizable number of flights in July due to the increased demand. As a result, AAL stock has jumped 37% in the past two weeks. Is the increase justified?
It’s true that American is adding back some capacity for the summer, but that is expected to be only 55% of the level in July 2019. Moreover, with social distancing and other preventive health measures in place, it is tough to imagine how the company will carry even that 55% passenger load.
On top of that, international flights will remain down by more than 80% year-over-year. Additionally, the company is worn down by its massive debt load, which will continue to grow if demand does not return to some normalcy. Let’s look at some of the factors which make AAL stock a bearish prospect at this point.
Traffic Doesn’t Necessarily Equal Profits
American’s July schedule suggests that booking trends are improving, and the airline sector could be heading toward recovery. However, demand is well below 2019 levels at this time and is expected to stay that way for the foreseeable future.
How “well below” is demand? One metric, TSA checkpoint data, shows that passenger traffic is down 85% year-over-year in recent weeks. These numbers could improve, but it’s tough to imagine how such deplorable levels of volume could help U.S. airlines make much money. This is especially true for a company like American, which has struggled with its net profit margins for most of the past decade.
Furthermore, these gradual improvements in traffic are less impressive when they are matched with remarkably low fares. Airline companies have been offering ridiculous discounts to generate sales but are ruining margins in the process. American Airlines, in particular, seems to be leading the pack in offering massive discounts at this time. Through the end of April, the company was selling one-way tickets between Miami and Los Angeles for $16 and a round-trip for only $32!
If its fares were similar to 2019 levels, the company’s cash flow forecast would’ve improved, but at this point, it is merely adding to the cash burn rate, which is expected to be around $6 billion in the second quarter alone.
Growing Debt Burden
American Airlines’ debt and lease obligations were at $33.4 billion at the start of 2020 and increased by 3% to $34.1 billion in the first quarter. It’s interesting to note that these figures were before the company starting burning any cash.
However, since then, the cash burn rate has magnified astronomically to $70 million a day in April, which is the highest rate for any air carrier. With its belt-tightening measures, the company has reduced that number to $50 million by June which implies a $6 billion cash burn in the second quarter.
Management is hopeful, though, that it would be in a better position after the second quarter with a 62% higher liquidity balance compared to the first quarter. What takes the sheen off that statistic is that a significant portion of this increase is attributable to CARES Act payroll support funds, which the company expects to receive in the second quarter. The funds total about $5 billion, and American may also consider tapping into the $4.75 billion secured loans under the CARES Act.
Since at least 30% of the payroll support comes in the form of a loan, that would mean that it would be taking an additional $6 billion in long-term debt and having already drawn roughly $3 billion in the second quarter, the debt and lease liabilities will be well over $40 billion by the second quarter. With demand not returning to 2019 levels any time soon, things could get bad for worse for American.
Looking Ahead
Despite the uptick, I’m not upbeat about the travel airline sector. A lot of it is down to the uncertainty surrounding the novel coronavirus and its long-term effects on consumption patterns. Besides, we are not even sure if there would be a second wave of infections that could force us back into lockdown again.
Airline companies are trying their best with lower fares and enhanced medical protocols to boost customer confidence. American Airlines announced that in its Admiral Lounge, it would have touchless access to restrooms, new plexiglass shields, sanitizer stations, and signage to encourage proper social distancing. All these efforts will put immense pressure on the company’s cost structure going forward.
Most experts believe that demand will remain suppressed for the long haul, and it may take more than two years before companies like American Airlines could return to profitability. At the same time, domestic competition between airline companies will squeeze margins further.
American is also looking to cut 30% of management and administration jobs due to the low demand. Elise Eberwein, the carrier’s executive vice president of people and global engagement, told employees that the company must “plan for operating a smaller airline for the foreseeable future.”
Final Word on AAL stock
American Airlines is in a tough spot heading into the latter half of the year. Its debt burden is gradually increasing, and with demand expected to be nowhere near pre-pandemic levels, American has its work cut out. AAL stock price had a bad run for most of last week — falling almost 23% — before Friday’s massive 16%+ rebound.
Still, analysts expect a mean price target of $12, which is 28% lower than its current price of $16.74. Therefore, I expect American’s woes to continue for the foreseeable future.
As of this writing, Muslim Farooque did not hold a position in any of the aforementioned securities.
