It has been a rough year for American Airlines (NASDAQ:AAL) stock, but the biggest hits are yet to come. The second quarter was the most turbulent in history for the legacy carrier.
Year over year, revenue fell to $1.62 billion, an 86.5% drop. From passenger revenue to the cargo business, there were no positive headlines that emanated from the earnings report.
However, that isn’t surprising. Everyone knows that the novel coronavirus pandemic severely dented the U.S. economy. Airlines, cruises and any other sector that require social gathering are firmly in the dumps.
But if you focus on AAL in particular, you will find that the airline is in much more trouble than any of its peers. Unfortunately, that has more to do with the company’s response to the crisis rather than the prevailing situation.
In a puzzling strategy, when most airlines have decided to streamline operations and cut spending, American Airlines chose to go down a different route. It seems it’s trying to already lay the groundwork for an eventual Chapter 11 filing, through pacifying all stakeholders, except shareholders.
Taking into account the enormous debt load and the improbability of positive free cash flow for the next few years, I would say it’s time to part ways with AAL stock.
Debt Is Choking the Life Out of AAL Stock
The biggest controversy surrounding airlines for a while has been their penchant for repurchasing stock to boost stock value. According to a Bloomberg article, American Airlines bought back over $12.5 billion of stock despite having negative cumulative free cash flow.
So, you can understand that the issues with American and some of its peers are not new, nor can they be totally blamed on Covid-19. At a time when the company should have been using its resources to increase earnings, AAL chose to focus on share repurchases.
As a result, when the virus struck, the airline was caught napping. In Q2, revenues fell 84.6% in comparison to the year-ago period. Operating loss came in at $2.49 billion, a sharp contrast to the operating income of $1.15 billion in 2019.
Meanwhile, as operational matrices were getting hammered, AAL was busy raising debt. At the end of June, total liquidity stood at $10.2 billion. The company is expected to receive $4.75 billion under the CARES Act, while AAL itself has launched an offering of $2.5 billion of senior secured notes.
However, the average daily cash burn rate in Q2 was $55 million, the highest among its peer group. Delta Air Lines (NYSE:DAL) has brought down its cash burn to $27 million in June; United Airlines (NASDAQ:UAL) is burning $25 million per day as per its latest quarterly reports.
Airline traffic is not returning to normal anytime soon. In the meantime, AAL has to contend with an additional $2 billion in interest costs and high cash burn. Non-existent revenues and negative FCF are already sizeable headaches. Increasing interest costs just exacerbate bankruptcy risks.
A Weird Strategy
When you hear from AAL execs these days, you often wonder if we’re in the middle of 1992’s Unforgiven. In that excellent western epic, Clint Eastwood essays the role of an aging gunslinger who’s brought in for one last round with a gang of bandits.
When Chief Revenue Officer Vasu Raja says things like, “swing for the fences,” or “we’re going to go bold” in response to the virus, he doesn’t instill a lot of confidence in equity investors. Instead, these words inspire fear that the management is in over its head.
During the company’s Q1 earnings call, Raja said that the airline did not have plans to shutter any hubs. This comes in sharp contrast to the strategies employed by other carriers that are flying fewer routes and streamlining operations to save costs.
Raja says the strategy will help keep morale up, a perplexing statement. Won’t confidence take more of a beating if the company can’t make interest payments and heads into bankruptcy proceedings? In that situation, loyal employees will lose their jobs, and investors will be left with nothing as AAL folds under a mountain of debt.
This “go big or go home” strategy is worrying shareholders and analysts alike. Investors want to see management taking result-oriented steps that can reduce cash burn. They want to see debt go down, older fleets retired and a substantial reduction in operating costs. There is nothing to suggest that operating low-income yielding hubs will lead to long-term profits or heightened morale.
Final Take on AAL Stock
Airline traffic will take time to return to normal levels. Even if we have a Covid-19 vaccine by the fall, you cannot immunize large swathes of the population overnight. However, that’s not the problem here. AAL management has chosen to go down a reckless route in response to the pandemic. Instead of hunkering down, it has decided to keep costs up and pile on debt. That is not a prudent strategy.
The airline doesn’t have the cash to keep paying the debt in a prolonged slowdown. It’s looking more and more likely that it will have to file for Chapter 11 sometime in the future. None of its debt matures before 2022, but high-interest costs could force its hand.
It’s high noon for AAL stock, and the carrier has come to the showdown without any bullets.
Faizan Farooque is a contributing author for InvestorPlace.com and numerous other financial sites. He has several years of experience in analyzing the stock market and was a former data journalist at S&P Global Market Intelligence. His passion is to help the average investor make more informed decisions regarding their portfolio. He does not directly own the securities mentioned above.