Top U.S. airlines like American Airlines (NASDAQ:AAL) and United Airlines (NASDAQ:UAL) hold enormous sums of cash and short-term investments on their balance sheets. They also supplement their liquidity with credit lines that allow them to draw billions of dollars.
With all of this readily accessible cash, you might think that these airlines could handle whatever curveballs nature and the economy might throw at them. Yet the escalating COVID-19 pandemic has sent the airlines into panic mode. Industry trade group Airlines for America recently requested that the federal government provide over $50 billion of aid to U.S. passenger airlines, with more than half of that coming in the form of grants and a suspension of excise taxes.
To some extent, this simply reflects the enormous revenue declines that airlines are expecting: particularly global carriers like American and United. However, airlines' reliance on advance ticket sales to help fund their businesses will also cause them to burn through huge sums of cash in a very short time.
Access to a lot of cash
In recent years, American Airlines and United Airlines have both maintained large cash balances as protection against an industry downturn. At an industry conference last week, American Airlines CEO Doug Parker said that his company had $7.3 billion of liquidity: more than any other airline in the world. That includes more than $4 billion of cash and investments and $3.2 billion available through revolving credit facilities.
As it happened, Parker's information was slightly out of date. A day earlier, United Airlines had borrowed $2 billion through a new 364-day term loan. That gave United approximately $6 billion of cash and short-term investments and total liquidity of $8 billion, including its $2 billion revolving credit facility.
Yet while $7 billion to $8 billion of liquidity might seem like a lot, it won't last very long the way things are going right now.
Revenue is evaporating
The most obvious reason why American Airlines and United Airlines face a looming cash crunch is that air travel demand is plummeting. Over the past week, a slew of airlines have said that net bookings have plunged to near zero or even into negative territory. With many countries closing their borders to nonresidents and public health authorities urging people to avoid all nonessential travel, it's no surprise that cancellations have started to outpace new bookings.
United Airlines President Scott Kirby said last week that the airline was planning for a worst-case scenario where revenue might plunge 70% in April and May before recovering slowly.
That estimate now seems more like a best-case scenario. In a message to employees sent last weekend, Kirby and company CEO Oscar Munoz said that United now plans to slash its capacity by 50% for April and May. Moreover, they wrote, "Even with those cuts, we're expecting load factors to drop into the 20-30% range -- and that's if things don't get worse." That implies a roughly 85% year-over-year plunge in traffic before things bottom out.
American Airlines hasn't provided the same level of detail. Still, given that it recently announced the suspension of virtually all long-haul flying through May 6, it's reasonable to guess that it's seeing similar booking trends.
Quarterly expenses typically exceed $10 billion for both American and United. To be fair, fuel costs have fallen by about 50% over the past few months (providing more than $1 billion of quarterly savings for each company), discretionary expenses can be slashed, and schedule cuts will reduce variable expenses. However, unless they implement mass furloughs to radically reduce labor costs -- which they have been trying to avoid -- American Airlines and United Airlines will post multibillion-dollar losses next quarter, due to the enormous revenue declines they face.
Working capital: another headache
The big operating losses that American Airlines, United Airlines, and their airline industry peers will incur next quarter are only part of the problem. Unfortunately, the airlines are also likely to experience a significant negative working capital movement that will accelerate their cash burn.
This stems from the fact that airlines typically sell many of their tickets months in advance. As of the end of 2019, American Airlines and United Airlines both reported advance ticket sales of $4.8 billion on their balance sheets. Typically, those figures swell during the first half of the year as advance bookings for summer travel pour in. In 2019, both carriers reported increases of more than $1.5 billion in outstanding advance ticket sales between the beginning of the year and June 30.
That usual pattern isn't likely to hold in 2020. Bookings have ground to a halt this month, so much of the (greatly diminished) revenue American and United will report over the next few months will come out of their existing pools of advance ticket sales. To put it another way, cash ticket sales will plummet even more than reported revenue, aggravating the airlines' cash outflows.
This explains recent changes to United Airlines' refund policy. United recently announced that for international flights that have been disrupted by more than six hours due to schedule cuts, customers will receive a travel credit good for 12 months and a full refund only if they haven't used the credit by the end of that 12-month period. While virtually every customer would prefer an immediate refund, this policy will prevent the advance ticket sales balance from falling even faster by delaying refunds into 2021.
With cash inflows slowing to near zero and expenses declining only modestly in the short term, American Airlines and United Airlines could start burning more than $500 million a week. At that rate, they could run through most of their existing liquidity by mid-May.
The Trump Administration has seemed receptive to the airline industry's call for financial support. However, it will take time to negotiate a bill, move it through Congress, and start to disburse money. In the meantime, American and United will likely need to raise additional capital, most likely by issuing secured debt backed by unencumbered aircraft and other assets.
Investors should also expect to see some big fare sales once the COVID-19 pandemic appears to be getting under control and demand starts to return. Airlines will be eager to bolster their cash balances by selling tickets for future travel, even if the fares are much lower than normal. That could extend the period of reported losses for many airlines, but crucially, it could get cash flow back to breakeven faster.
The big unanswered question is how long it will take for air travel demand to come back in a meaningful way. That will depend largely on when the rate of new COVID-19 cases in the U.S. starts to taper off. If we reach that point in two or three months, American Airlines and United Airlines should be able to survive with only a modest amount of federal aid. But if air travel demand remains virtually nonexistent for six months or more, these airlines and their employees will need a lot of help to get by.