Things are finally looking up for the airline sector. After a horror show of a year, U.S. airlines report signs that travel demand is perking up, suggesting the start of a rebound from an unprecedented collapse because of the novel coronavirus pandemic. However, there’s a danger the markets are already pricing in the recovery before it happens. Just as an example, American Airlines (NASDAQ:AAL) stock has a one-month return of almost 30%, while the industry and S&P 500 have returned 5.4% and 4.4%, respectively.
The novel coronavirus pandemic will eventually recede to the background. Vaccines made by Pfizer (NYSE:PFE) and Moderna (NASDAQ:MRNA) are now being rolled out steadily. However, it will take time to vaccinate vast swaths of the U.S. population. But the important thing to note here is that we finally see concrete action on this end.
That has caused several stocks in the space to show some positive price action after several months finally. But it’s a widespread belief that it will take time for airline traffic to return to pre-pandemic levels. Many airline stocks have already crossed their consensus targets. JPMorgan believes the recent rally has significantly reduced the implied potential upside to price targets.
That is certainly the case with AAL stock trading at a 31% premium to the 12-month price target of $11.40 per share. Management certainly deserves a pat on the back for steadying the ship during troubled times. But as my colleague Nicolas Chahine points out, I would wait for AAL to dip again before I jump in.
Stop the Bleeding
The last time I wrote about AAL stock, I praised the management for finally taking the necessary steps to steady the ship after the pandemic wreaked its operations. TSA checkpoint travel numbers still show a wide discrepancy between last year’s figures and the passenger count at the moment.
Considering the slow rollout of vaccines – essential healthcare workers will get access before the general population – we can expect air travel demand to lag for a few more years.
But we are mobile creatures, after all. So, I don’t expect demand to remain depressed for long. But the figures indicate that it will take a while before we see passenger numbers notch up once again. In this environment, AAL has done all to boost liquidity while waiting for demand to rebound to pre-pandemic numbers.
The company’s third-quarter pro forma liquidity balance is roughly $15.6 billion. It expects to end the fourth quarter with more than $13 billion in total available liquidity, comprising a mix of debt, equity and cash saved from reducing capital expenses. I won’t talk about dilution at this stage. Obviously, you wouldn’t want to issue 38.5 million shares to shore up cash for the balance sheet in an ideal scenario. But that’s where we are.
In addition, AAL finalized a $5.5 billion loan with the U.S. Department of the Treasury through the CARES Act loan program. In October, it boosted its loan capacity to $7.5 billion. CARES Act loans come with several provisions that airlines have to stick to, particularly when it comes to furloughing and laying off personnel. That limits an airline’s capacity to reduce costs. But as was the case with the equity issue, the company needs the capital to keep running.
Cash Burn Is Reducing
One of the major health indicators for airlines these days is cash burn. On that front, AAL has done well. Daily cash burn was approximately $44 million per day in the third quarter from $58 million per day in the second quarter. It originally forecasted its fourth-quarter cash burn rate to be approximately $25 to $30 million per day. In a stock filing from Dec. 4 filing, AAL said a higher average daily cash burn for the fourth quarter to come in near $30 million. So, it’s definitely trending towards the higher side of guidance.
Heading into the fourth quarter, airlines were hoping to get nearly three weeks of solid demand due to the Thanksgiving and the December holiday period. But the pandemic is back in full force in the winter season. Cases are surging, and the situation is worse than in the summer. Plus, fuel prices are rising, albeit slowly. That’s also having an impact on the bottom line.
At the start of this crisis, AAL didn’t go ahead and shutter most of its operations, as was the case with other airlines. That attitude has changed, and management deserves credit for it. Its partnership with JetBlue (NASDAQ:JBLU), which will unlock some new transatlantic routes, allows American to continue to maintain its positions in Boston and New York without incurring hefty operational costs.
Plus, AAL has retired more than 150 aircraft from its fleet through early retirements or by placing aircraft into temporary storage. Non-aircraft capital expenses have also been slashed by $700 million in 2020 and another $300 million in 2021.
What to Do With AAL Stock?
AAL stock isn’t a buy right now. Covid-19 did a number on travel demand and caught the airline at the wrong time. Technicals and fundamentals are still weak. However, the optimism surrounding the wider recovery is pushing airline stocks higher at this time. There is a lot of pent-up demand that will unleash once we see commercial vaccines available. We saw that when transmission risks fell in the summer, domestic demand started to look up.
Management is conscious of cutting costs and streamlining operations. From a valuation perspective, AAL is cheaper than its peers trading at a 0.3x price-sales; United Airlines (NASDAQ:UAL) at 0.5x, Southwest (NYSE:LUV) at 2x, Delta Air Lines (NYSE:DAL) at 1.1x. American Airlines stock is respecting its key moving averages and retracement levels.
AAL stock has a one-year beta of 1.3x, meaning it’s highly volatile. I would dip my toes only if I were willing to hold onto this stock until late 2021. The pandemic effects won’t be over by the end of next year, but I believe the combination of low fuel prices and affordable flights will make AAL an interesting proposition.
In the interim, shares will remain volatile, ebbing, and flowing with each new piece of news. Much of which has nothing to do with the company’s fundamentals.
On the date of publication, Faizan Farooque did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Faizan Farooque is a contributing author for InvestorPlace.com and numerous other financial sites. Faizan has several years of experience 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.
