The rapidly spreading COVID-19 pandemic has wreaked havoc on the airline industry over the past month. In recent weeks, the leaders of virtually every major U.S. airline have warned that booking activity has plunged to negligible levels. Some airlines are projecting revenue declines of 80% or more for the second quarter. This has sent airline CFOs scrambling to line up new sources of liquidity and forced airlines to implement unprecedented near-term capacity cuts.
Not surprisingly, airline stocks have plunged because of this crisis. Shares of global airline giants American Airlines (NASDAQ:AAL) and United Airlines (NASDAQ:UAL) have been among the big losers. On a year-to-date basis, they have fallen 64% and 73%, respectively. Nearly all of those declines have come in the past month.
However, while some airline stocks could be worth buying due to this steep sell-off, American Airlines and United Airlines don't fit the bill. Both companies entered 2020 with too much debt, making them ill-equipped to absorb the losses they are likely to incur this year -- even with government assistance. Furthermore, it could take a long time for their profitability to recover from this sharp downturn.
Two airlines with a lot of debt
In recent years, American Airlines has maintained the dubious distinction of being the most-indebted airline in the U.S. This came as a result of management's ill-conceived strategy of spending heavily on capex and share buybacks simultaneously.
At the end of 2019, American had a stunning $33.4 billion of debt and lease liabilities, offset by just $3.8 billion of unrestricted cash and short-term investments. That put its net debt at more than four times the company's 2019 adjusted earnings before interest, taxes, depreciation, amortization, and rent.
United Airlines has a significantly better balance sheet, but it still has a little too much debt for comfort. It reported debt and lease liabilities of $20.5 billion at the end of 2019, offset by $4.9 billion of cash and investments.
These heavy debt burdens are problematic because airlines will have to take on additional debt to get through the COVID-19 pandemic. Industry lobbying group Airlines for America has been requesting a mixture of grants (or payroll assistance) and loans to help airlines navigate the current crisis, but so far politicians haven't been willing to go beyond loans or loan guarantees.
Look for a lot of cash burn ahead
With demand evaporating, airlines are set to burn through cash rapidly over the next few months. Last Wednesday, JetBlue Airways said that new bookings had fallen to less than $4 million per day, compared to $22 million for a typical day in March 2019. Meanwhile, the airline has been issuing over $20 million of credits a day for canceled flights: more than 10 times the normal rate. On Friday, Delta Air Lines said it was burning through $50 million a day despite deep cost cuts.
While American Airlines and United Airlines haven't provided quite as much detail, there's no reason to believe they are in better shape than any of their rivals. Both have scheduled deep capacity cuts for the months of April and May and are looking to reduce labor costs. United Airlines recently became the first airline to publicly raise the prospect of mass furloughs, saying that "if Congress doesn't act on sufficient government support by the end of March, our company will begin to take the necessary steps to reduce our payroll in line with the 60% schedule reduction we announced for April."
American and United are similar in size to Delta, so it's reasonable to guess that they are also burning through at least $50 million a day. The good news is that both carriers have plenty of liquidity for now, following recent actions to secure additional loans and credit facilities. As of March 9, United had $8 billion of liquidity; as of March 18, American had $8.4 billion of liquidity.
The bad news is that unless conditions improve, they could burn through more than half of this cushion by midyear. Large-scale furloughs would slow (but not stop) the bleeding. Moreover, furloughs are a double-edged sword, as they would alienate employees in an industry that already suffers from high labor tensions.
In short, there are no good options for airlines. Moreover, American Airlines and United Airlines (especially the former) have less flexibility than most, since they came into this crisis with high debt levels. Barring substantial cash assistance from the federal government, both carriers will exit 2020 with far more debt on the books than they have today, hurting their ability to invest in their businesses and limiting their flexibility to respond to future challenges.
Don't expect a quick rebound in profits
The big increases in debt that are likely at American Airlines and United Airlines this year wouldn't be so disastrous if the carriers could count on a return to favorable business conditions in 2021 and beyond. Unfortunately, it could take a long time for global network carriers like American and United to recover from this global pandemic.
First, the threat from COVID-19 may not be fully contained until a vaccine is available, which probably won't happen until at least late 2021. Even if the spread of COVID-19 slows well before then, many people may be reluctant to get on an airplane until they've been vaccinated.
Second, the national and global response to the pandemic has already plunged the economy into a recession, according to many analysts. It could be a short-lived recession if aggressive fiscal stimulus restarts the economy after the number of COVID-19 cases starts to decline -- but that won't necessarily be the case. A recession could put pressure on unit revenue throughout the airline industry, as lower fares might be necessary to stimulate demand.
Third, global airlines like American and United are particularly reliant on high-fare business travel and sales of pricey premium seats, especially on long-haul routes. If companies that are experiencing profit pressure slash their corporate travel budgets, it would have a particularly big impact on these carriers. Airline executives appear to realize this. Delta Air Lines has already warned staff to expect a slow recovery and that the airline may have to shrink significantly before eventually returning to growth; American Airlines is offering early retirement options to some employees in order to permanently reduce its headcount.
All three factors mean that profitability may remain depressed at American Airlines and United Airlines in the years ahead, even after traffic starts to return. This, combined with their high debt loads, makes these two airline stocks extremely risky. It's possible they will stage a full recovery, but it's more likely that they will remain well below their previous highs for the foreseeable future.
Stick to safer choices
The U.S. government isn't likely to let any major airlines fail due to the COVID-19 pandemic, because of the number of people they employ and their importance to the U.S. economy. Yet a rescue program limited to loans (which is the only option on the table so far) would only be a short-term fix. It might give a brief lift to airline stocks across the board, but heavily indebted companies like American Airlines and United Airlines would then have to figure out how to manage even higher debt loads in a world where profitability could be weak for several years.
Airlines that entered 2020 with strong balance sheets, have lower costs, and primarily serve the short-haul leisure and visiting-friends-and-relatives markets -- where demand tends to hold up better during recessions -- are more attractive. With lower debt and a higher chance of returning to solid profitability within a year or two, those airline stocks are less risky and more likely to stage a strong recovery than shares of American and United.