American Airlines (NASDAQ:AAL) stock will soon feel the repercussions of its decision to largely eliminate social distancing safeguards. The company recently announced that as of July 1st it is going to begin filling middle seats and disregarding prior social distancing rules. Justification has come in the form of newly released cleaning guidelines and a partnership with Vanderbilt University.
As American sees load factors rise, Wall Street may well reward shareholders. Avoid investing in American Airlines stock as it is simply shows further signs of distress.
Public Relations and Public Health
American Airlines has recently announced it has aligned itself with Vanderbilt University, its highly regarded hospital system and the experts working there. American’s PR hopes aside, this relationship is simply an advisory role. This changes very little for American Airlines. Guidelines and recommendations, no matter how well-respected the authority, don’t have legal weight.
Vanderbilt’s experts will simply be giving American Airlines’ management advice, which management is free to accept or reject. The company also took time to rehash measures for cabin disinfection in the same note. So, there’s really no news there. The important news is that American flights will be fuller.
AAL Stock May Rise, but at What Cost?
American will have fuller flights come July 1. The question becomes, is this a good decision? Investors might agree that it is, but imagine yourself or your loved ones on that same plane and the calculus may change. Then again, perhaps blocking middle seats has no effect in decreasing the spread of the novel coronavirus, given the already small distance between seats. But given the resurgence of cases and the toll of human lives already seen, caution seems wise.
These are unprecedented times and American Airlines’ decision regarding social distancing rules has one of two outcomes. Shares could rise on the positive economic optics of the decision, or drop should enough investors view this as irresponsible. The most likely outcome in my mind is that markets will reward American initially. Shares will then trade higher barring any outbreak directly attributable to the company itself. But prices are going to also be subject to the upcoming earnings report which won’t be rosy.
Load Factors and Profitability of AAL Stock
The Allied Pilots Association asked American why it isn’t re-introducing idle fleet rather than packing flights to serve more customers. This is less profitable than packing a plane full, but if the planes are sitting idle, they could be put back online risking public health less.
JetBlue (NASDAQ:JBLU) chief executive, Robin Hayes, stated that break even points generally occur at 75-80% load factors in the airline industry. That American Airlines is prioritizing fuller flights certainly fuels the narrative that revenue is priority one.
American increases operational efficiency the more passengers it can transport per flight. And of course, the lower the load, the more expensive it becomes to operate flights. Investors should be hesitant to give American the benefit of the doubt here. The truth is that financial strength, or lack thereof, tracks nicely with a given airline’s willingness to open middle seats. The entire industry is subject to very similar situations, yet other operators are blocking middle seats.
Which Carriers Are Maintaining Blocked Seats and Why?
Delta (NYSE:DAL) and Southwest (NYSE:LUV) are committed to blocking middle seats. Delta will not be opening middle seats until at least Sept. 30 and Southwest has stated that it will only open middle seats for certain passengers traveling together. United Airlines (NASDAQ:UAL) has gone back and forth but essentially it isn’t enforcing any social distancing.
Southwest and Delta came into the pandemic with the strongest balance sheets among carriers. United Airlines was middle of the pack, and American Airlines the laggard. How much that need for revenue correlates to a given airline’s choice to ease social distancing? I can’t say, but there is a clear association.
But most importantly from a financial perspective, American has taken on massive debt. It is going to be over-leveraged for some time. Pundits will point to maturity dates on that new debt and dismiss it. They will contend American needs simply to show positive cash flow near term and then the debt will be easily paid down when maturity arrives. That might be true, but it isn’t an efficient use of capital. Investors should seek to invest in lower debt companies, rather than seek to explain away the debt of existing investments. The fact is American has about $38.5 billion in debt and a net debt-to-capital ratio of 109%.
Takeaway On American Airlines
A few weeks ago I argued against buying AAL stock based on the idea that shares wouldn’t rise despite having fallen so far. The company was over-leveraged then, and more so now. Those things are still true, and now I’d also say that it is arguably being irresponsible with the health of the public. If you want to invest long-term in major airlines, my opinion remains the same now as it was then: consider Southwest and Delta. They were in better positions coming into this pandemic as a result of prudent decision making. That gave them stronger balance sheets. Their stronger balance sheets have allowed them to make better decisions throughout the pandemic. They’ll come out stronger, and rise faster for the same reasons.
As of this writing Alex Sirois did not own shares of any of the aforementioned stocks.