What Should American Airlines Do With $10 Billion in Cash?

How will American Airlines' massive cash holding affect shareholders?

Jan 21, 2014 at 10:49PM

Last year marked a major event in commercial aviation history, as American Airlines Group (NASDAQ:AAL) was formed by the merger of US Airways and AMR. There is clearly a lot of potential at the new airline, but what is attracting a lot of attention lately is the airline's $10 billion in cash.

Using cash
Airlines are in a naturally volatile business, and any use of cash has to take into account the massive capital needs in the industry as well as the cyclical nature of earnings. That said, finding the right balance of saving for a rainy day and generating shareholder returns is the most beneficial strategy for airline shareholders. With $10 billion in cash, American Airlines Group will need to work on striking this balance.

Fleet modernization
Part of the rebuilding of American Airlines has been a massive fleet modernization initiative. With more than $40 billion in aircraft on order, American has committed a large amount of its capital to the latest aircraft technology. American will probably use a good portion of its cash for these new aircraft to prevent it from having to issue more debt than necessary.

Overall, this fleet modernization should benefit the airline in the long term through reduced fuel consumption and maintenance costs. Additionally, American is building its brand around having the youngest fleet of major U.S. airline. Although it may get in the way of short-term shareholder returns, fleet modernization can be considered a reinvestment in the core business and should still be considered a responsible use of cash.

Share buybacks
With the large commitments American has already made to purchasing new aircraft, I tend to favor share buybacks over dividends at this airline. For share buybacks to be accretive for shareholders, they must be done at a reasonable valuation. American is currently trading at a single-digit forward price-to-earnings ratio implying that shares are fairly valued, if not undervalued.

The second part is whether the company is stable enough to execute a buyback without threatening its solvency. Since American has significant earnings power and can set the buyback amount at a level of its own choosing, the airline meets the requirement for the second point.

Buybacks also carry an advantage over dividends in that they can be turned on or off much easier. Buybacks typically run for a certain period of time and for a certain amount of money or shares. At that point, the company can reassess its financial situation and decide whether it makes sense to continue. In contrast, dividends are expected to be either held stable or constantly increased. If a company were to cut or eliminate its dividend, even if its the most financially responsible thing to do, shares would be punished because the market would see a red flag. Launching a share buyback at current levels would give American the ability to grow shareholder value while not committing to a long-term payout.

A similar buyback program was a core part of the capital return plan for Alaska Air Group (NYSE:ALK), which continued a share buyback program from long before it initiated a dividend in 2013. Quite likely, Alaska enjoyed the flexibility of a buyback program, especially as a growing airline looking for opportunities.

The place for dividends
Even as I prefer a share buyback over a dividend, I recognize there is an advantage to a dividend. Many funds have a mandate to only purchase dividend-paying stocks -- and paying a dividend, even a tiny one, makes a company's stock eligible to be purchased by these funds.

If American Airlines Group does decide to pay a dividend, expect it to be a small one -- possibly a yield less than 1% as seen at Alaska Air Group and longtime dividend-paying Southwest Airlines (NYSE:LUV). In the highly capital-intensive airline industry, large dividends are not something carriers like to commit to, especially considering the volatile nature of airline profits.

Cash management
Ten billion dollars seems like a lot of money, but for an airline the size of American Airlines Group, this is far from free money to return to shareholders. Over the next several years, American will be taking delivery of hundreds of new aircraft while working to build the world's largest airline.

If American does decide to take additional steps to boost shareholder value, I would expect a share buyback to play a greater role than a dividend because of the current valuation of American Airlines shares and the flexibility available with a buyback. Investors must remember that the airline industry is still a capital-intensive one and that American will almost certainly continue to hold much of this $10 billion as cash.

Nine top stocks with bigger yields
One of the dirty secrets that few finance professionals will openly admit is that dividend stocks as a group handily outperform their non-dividend-paying brethren. But knowing this is only half the battle. The other half is identifying which dividend stocks in particular are the best. With this in mind, our top analysts put together a free list of nine high-yielding stocks that should be in every income investor's portfolio. To learn the identity of these stocks instantly and for free, all you have to do is click here now.

Alexander MacLennan owns shares of and has options on American Airlines Group. This article is not an endorsement to buy or sell any security and does not constitute professional investment advice. Always do your own due diligence before buying or selling any security. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

A Financial Plan on an Index Card

Keeping it simple.

Aug 7, 2015 at 11:26AM

Two years ago, University of Chicago professor Harold Pollack wrote his entire financial plan on an index card.

It blew up. People loved the idea. Financial advice is often intentionally complicated. Obscurity lets advisors charge higher fees. But the most important parts are painfully simple. Here's how Pollack put it:

The card came out of chat I had regarding what I view as the financial industry's basic dilemma: The best investment advice fits on an index card. A commenter asked for the actual index card. Although I was originally speaking in metaphor, I grabbed a pen and one of my daughter's note cards, scribbled this out in maybe three minutes, snapped a picture with my iPhone, and the rest was history.

More advisors and investors caught onto the idea and started writing their own financial plans on a single index card.

I love the exercise, because it makes you think about what's important and forces you to be succinct.

So, here's my index-card financial plan:


Everything else is details. 

Something big just happened

I don't know about you, but I always pay attention when one of the best growth investors in the world gives me a stock tip. Motley Fool co-founder David Gardner (whose growth-stock newsletter was rated #1 in the world by The Wall Street Journal)* and his brother, Motley Fool CEO Tom Gardner, just revealed two brand new stock recommendations moments ago. Together, they've tripled the stock market's return over 12+ years. And while timing isn't everything, the history of Tom and David's stock picks shows that it pays to get in early on their ideas.

Click here to be among the first people to hear about David and Tom's newest stock recommendations.

*"Look Who's on Top Now" appeared in The Wall Street Journal which references Hulbert's rankings of the best performing stock picking newsletters over a 5-year period from 2008-2013.