It’s been a demanding year for American Airlines (NASDAQ:AAL) stock, however, the greatest hits are yet to emerge. The second quarter has been the most tumultuous in history for its heritage carrier.
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Year over year, earnings fell to $1.62 billion, an 86.5% fall. From passenger earnings to the freight business, there weren’t any positive headlines which emanated in the earnings report.
But, that isn’t surprising. Everybody knows that the book coronavirus pandemic badly simplifies the U.S. market. Airlines, cruises as well as some other industry that need social collecting are firmly at the dumps.
But if you concentrate on AAL particularly, you’ll discover that the airline is much more trouble than some of its peers. Regrettably, that’s to do with all the company’s answer to this emergency instead of the prevailing scenario.
In a perplexing strategy, when many airlines have opted to streamline operations and reduce spending, American Airlines decided to go down another path. It appears it’s hoping to lay the groundwork for an eventual Chapter 11 submitting, through pacifying all stakeholders, except shareholders.
Taking into consideration the great debt burden and the improbability of favorable free cash stream to the upcoming few decades, I’d say it’s time to part ways with AAL stock.
Money Is Choking the Life Out of AAL Stock
The largest controversy surrounding airways for some time has been their penchant for repurchasing stock to increase stock value. According to a Bloomberg article, American Airlines purchased back over $12.5 billion of stock despite getting adverse accumulative free cash flow.
Thus, you can realize that the difficulties with American and a number of its peers aren’t new, nor will they be completely blamed on Covid-19. In a time once the business should happen to be utilizing its resources to raise earnings, AAL opted to concentrate on share repurchases.
Because of this, once the virus struck, the airline has been caught napping. In Q2, earnings dropped 84.6% compared to this year-ago period. Running loss came in at $2.49 billion, a sharp contrast to the working earnings of $1.15 billion in 2019.
Meanwhile, as functional matrices were getting hammered, AAL was occupied increasing debt. In the end of June, overall liquidity stood at $10.2 billion. The business is expected to get $4.75 billion under the CARES Act, whilst AAL itself has established an offering of $2.5 billion of senior secured notes.
On the other hand, the typical daily cash burn in Q2 was $55 million, the highest among its own peer group. Delta Air Lines (NYSE:DAL) has brought down its cash burn to $27 million in June; United Airlines (NASDAQ:UAL) is burning off $25 million daily according to its latest annual reports.
Airline traffic isn’t returning to normal anytime soon. Meanwhile, AAL must compete with an extra $2 billion in interest expenses and large 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 InvestorPlaceoff.com and numerous other financial sites. He has several years of experience in analyzing that the stock market and was a former data journalist at S&P Global Market Intelligence. His passion is to this average investor make more informed decisions regarding their portfolio. He does not directly own off the securities mentioned previously.