American Airlines (NASDAQ:AAL) stock has shed 66% of its value year-to-date. The company posted a $2.2 billion loss in its first quarter, a massive decline from the year-ago profit of $185 million. Revenues are down 19%, and uncertainty looms over the upcoming quarters. What does this all mean for AAL stock?
“We all expect that recovery will be slow, and demand for air travel will be suppressed for quite some time,” CEO Doug Parker told investors in an earnings call recapping the first quarter.
The uncertainty surrounding the airline industry has sent shock waves down the spines of investors holding airline stocks. Warren Buffett of Berkshire Hathaway (NYSE:BRK.A, NYSE:BRK.B) recently announced that his firm had sold its entire holdings in the four major U.S. airlines. Most investors are likely to follow suit as the sector battles for survival.
It’s clearly not the best time to hold AAL stock. But there’s even one more reason why investors need to be cautious moving forward.
A Growing Debt Burden Weighs on AAL Stock
American Airlines has struggled to keep its liabilities in check, putting the company in a precarious position. On top of that, the company’s cash flow often is negative.
The company’s net debt stands at $21.5 billion. This figure excludes the $4.75 billion stimulus payments it will receive from the government and the additional $1.7 billion for payroll support. These amounts will take debt levels to $28 billion, which is a 30% increase from the latest quarter.
In addition to this, short-term liquidity numbers have also been weak, as the company’s working capital has consistently fallen in the past five years. With negative free cash flow numbers for the past three years, it is tough to say whether the company can escape its debt trap anytime soon.
Warren Buffett’s Mistake
Berkshire Hathaway divested its stake in four of the major U.S. airlines at the beginning of May. The firm held an 11% stake in Delta Air Lines (NYSE:DAL), 10% in American Airlines, 10% in Southwest Airlines (NYSE:LUV) and 9% in United Airlines (NASDAQ:UAL) at the end of 2019.
Buffett said the “world has changed” for the aviation industry, and he admitted pouring capital in the sector was a mistake of his. More importantly, it’s a mistake he regrets.
The billionaire has been skeptical of the airline industry in the past, and has warned investors about how it has regularly destroyed investor capital. However, he changed his mind several years ago and built up a sizeable portfolio of top airline stocks. Buffett’s recent move to divest his stake in the industry can be best explained by Berkshire Hathaway’s core philosophy. It seeks to find an outstanding business at a sensible price, not a mediocre business at a bargain price.
Three of the four airline companies — Southwest, Delta and United — have had a good track record of earning high margins and producing healthy free cash flows. Therefore, it was understandable for Buffett to invest in these businesses. However, these investments are more speculative now. With profits eroding, it was a safe bet to exit the market.
American Has a Gloomy Future Ahead
Even after the world returns to some sense of normal, it appears that the airline will have a dark cloud hanging over its head. Virus fears and the recessionary impact of the pandemic could affect travelers for a very long time. Just recently, Warren Buffett said, “I don’t know that three or four years from now, people will fly as many passenger miles as they did last year.”
These claims have been backed up by American Airlines and other carriers. They feel it may be a long time before demand will return to pre-pandemic levels. The stimulus package will help companies shore up their revenues, but they might have to shrink going forward.
Airline companies have reported billions in losses in the first quarter, and the second quarter should be even worse. The daily cash burn in the second quarter is likely to exceed $70 million a day. If the company’s cost initiatives are successful, it could lower that amount to $50 million a day.
According to Refinitiv, American Airlines has an earnings rating of 2, which is significantly lower than the industry average of 5.5. The first-quarter earnings per share were a loss of $2.65, which is 13.8% below the consensus for a loss of $2.33. The estimates for the second quarter have tanked to a loss of $7.65, which represents a 188% decline from the first quarter.
The Bottom Line on AAL Stock
Airline stocks have arguably suffered the most due to the novel coronavirus. Carriers have parked jets and slashed staff salaries. They are desperately looking for ways to decelerate the rate at which they are burning through their cash reserves. As demand remains in free-fall, companies are looking at stimulus packages, share buybacks and loading up on more debt to sustain their business until the dust settles.
As people continue to practice social distancing, it is tough to imagine how demand will substantially increase. American Airlines is heavily debt-ridden and has been unable to produce positive free cash flows for a considerable period. Analysts estimate that the second quarter will be even worse with the company looking just to survive.
Therefore, it would be best to follow Buffett’s lead and sell AAL stock.
As of this writing, Muslim Farooque did not hold a position in any of the securities mentioned above.
