For Airlines, Cash Can Be a Fickle Thing

The troubled history of the airline industry since 2000 drove many airlines to build up big cash stockpiles. Faced with the constant threat of bankruptcy, airlines tried to keep as much cash on hand as possible in case of a crisis.

Today, industry conditions have improved dramatically, and Delta Air Lines (NYSE: DAL  ) has taken the lead among the big network carriers in returning cash to its shareholders. Last year, the company began paying a dividend and initiated a share buyback program, and it is expected to increase its capital returns later this year.

Delta Air Lines began returning some of its cash to shareholders last year.

Most investors expect American Airlines (NASDAQ: AAL  ) and United Continental (NYSE: UAL  ) to follow suit soon. American Airlines investors are particularly anxious to get a piece of the company's $10.3 billion cash hoard. However, United Continental's experience in the last few years shows that cash can disappear quickly in the airline business.

United's shrinking cash stash
United entered its merger with Continental Airlines with a massive cash stockpile. The two companies merged in October 2010 with a combined $9.1 billion in cash and investments on their balance sheets.

Fast-forward to the end of 2013, and United was down to less than $5.2 billion in cash and investments. Of the $4 billion in cash that has disappeared from United's balance sheet in the last three-and-a-half years, none has been returned to shareholders. So where did the money go?

United Continental has used $4 billion of its cash since its merger.

First, United Continental has paid down some of its significant debt obligations. At the end of 2010, the company had $13.8 billion in debt. By the end of last year, that was down to $12.4 billion, using up $1.4 billion of cash.

Second, in the last three years, United Continental has incurred more than $2.4 billion in costs classified as special items. Most of these charges are related to merger integration, and many of them have involved cash payments.

Third, United has started to spend a lot of money on capital expenditures in order to make up for under-investment during the previous decade (when the company was often short on cash). After spending less than $1 billion on CapEx in 2011, United spent $2 billion in 2012 and $2.2 billion in 2013.

Lastly, United's profitability fell dramatically due to integration problems beginning in 2012. Adjusted earnings fell more than 50% that year from $1.32 billion to $589 million, and United was not able to fully recover to its 2011 level of profitability last year.

Deja vu?
Considering how much cash United Continental has gone through in the last several years, the $10.3 billion cash pile at American Airlines doesn't seem as big. American Airlines faces some of the same issues that United did a few years ago. As a result, it could use up a large proportion of its cash stockpile before it has an opportunity to return some to shareholders.

First, American Airlines has nearly $17 billion in debt on its books. Roughly half of that amount is due in the next 5 years. Earlier this year, CEO Doug Parker told employees that paying down debt will be the company's first priority in terms of allocating its cash.

Second, Parker has stated that American needs to make some "catch-up" capital investments, just as United Continental did. American already has commitments to spend $19.5 billion on new aircraft and engine purchases in the next 5 years. Any non-aircraft capital expenditures would add to that total.

American Airlines plans to spend tens of billions of dollars on new planes. Photo: American Airlines.

Lastly, American Airlines expects to incur $1.2 billion of cash integration costs over the next two years.

On the flip side, American Airlines is currently much more profitable than United. That said, it has not reached the toughest stage of the integration process yet: converting to a single passenger reservation system. United performed quite well during the first year or so after its merger, and it was only later that integration problems undermined its profitability.

Cash can disappear quickly!
The key takeaway here is that airlines can run through billions of dollars of cash in a very short time. Even for a profitable airline, a high debt load and heavy capital expenditures can soak up more cash than the business generates. Thus, United Continental shareholders have seen what was once a massive $9.1 billion cash pile drop by nearly 50% in a few short years.

The lesson for American Airlines shareholders is that while the company has more than $10 billion in cash right now, most of that money is needed for things like paying off debt, buying new aircraft, and funding integration expenses. Only a small proportion of American's massive cash pile is likely to be available for dividends and share buybacks.

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