Major U.S. airlines -- American (NASDAQ:AAL)Delta (NYSE:DAL)United (NASDAQ:UAL), and Southwest (NYSE:LUV) -- are drastically cutting flights. In the age of coronavirus, this isn't surprising.

They're also asking for a bailout. It started with a request for $50 billion from the federal government. That number has since been revised down to $29 billion.

In the narrative put out by the airlines, this makes sense: How can an industry with such high capital requirements (gas, upkeep, new planes, etc.), and low profit margins possibly withstand a prolonged drought? 

But there's another narrative backed up by cold, hard facts: These airlines have had every chance in the world to prepare and have willfully chosen not to. That reality could lead to the end of buybacks in the industry -- and perhaps others -- for the foreseeable future.

An empty airline cabin.

Image source: Getty Images.

The reality: Business has been solid

Between the end of 2014 and 2019, these four major airlines have experienced marked success. Combined, they produced $34.6 billion in free cash flow (FCF). Here's how that all broke down.

Chart showing free cash flow to major U.S. airlines over time

Chart by author. Data source: SEC filings. Figures rounded to nearest $0.1 billion.

Some (Delta and Southwest) have done better than others (United and American). That's to be expected. 

What can airlines do with extra cash?

When companies have excess free cash flow, they have four general options:

  • Keep it: Companies can keep the money in the bank or short-term investments. 
  • Reinvest it: Airlines can upgrade planes and facilities, pursue new markets, or pay their employees more.
  • Pay it out: Shareholders can get dividends.
  • Buy back stock: By repurchasing shares, the total sharecount shrinks, creating more value for existing shareholders.

For the purposes of this article, we're going to focus on the last one -- stock buybacks. Here's why:

  • Keep it: When you keep cash on the balance sheets, short-term investors might not like it. But you become much more stable. Interruptions like the one we've seen aren't abnormal (see: 2001), so it's prudent to prepare for a future without needing a government bailout.
  • Reinvest it: While reinvesting costs money, at least that money then filters through the economy. The companies that provide parts to the airlines pay their employees more, who can buy more things, and so on...
  • Pay it out: When investors get regular dividends, they can decide what to do with them -- buy more stocks, take the money out for a new house, buy more gifts for the grandkids. The possibilities are limitless.

But buybacks have two ugly consequences we don't talk about enough. First, they often help hide ridiculous executive compensation (more on that below). More importantly, when "black swans" like coronavirus hit, shares of airline companies plummet -- rendering the economic value of share repurchases almost entirely moot.

They spent how much?

Okay, so how much was actually spent on these buybacks over the same timeframe? The answer: $38.6 billion.

Full stop. The airlines have spent more in share repurchases over the past five years than they've taken in via free cash flow. How can they afford to do that? By taking on more debt.

Here's a breakdown for each company.

Chart showing free cash flow and share buybacks at major airlines over time

Chart by author. Data source: SEC filings. Figures rounded to nearest $0.1 billion.

It would be easy to lay the entire blame at the feet of American Airlines. Clearly, American is the most egregious offender by a country-block. But that doesn't absolve Delta, Southwest, or United. The executives at these companies know full well they are in an industry uniquely exposed to black swans (again, does anyone remember September 11th?).

And yet they choose share buybacks. Why? Part of this is to satisfy institutional investors who own a large chunk of shares. But another is to cover up their own excess. Here's a telling calculation put together by using data compiled by Ben Hunt at Epsilon Theory.

Airline CEO Stock-Based Value (Payments) per Year as CEO
Delta Ed Bastian $36 million/year
American Doug Parket $31 million/year
Southwest Gary Kelly $13 million/year
United Oscar Munoz $6 million/year

Data source: Compiled by Ben Hunt using Form 4 documents on the SEC's EDGAR database. All figures rounded to nearest million.

When companies choose to pay their executives with stock-based compensation, that creates more shares outstanding. Existing shareholders -- people like you and me -- are diluted. But if the company uses its excess cash to repurchase shares, share-count actually falls at the same time executives are raking in these bonuses.

What should we do?

All of this leaves the American public -- and federal officials -- in a tight spot. Few want the airlines to disappear, but that's what could happen without some infusion of cash.

At the same time, executives have clearly demonstrated their eyes are set on profit maximization -- which only increases the chances of us finding ourselves in the same situation again.

As Hunt put it in his piece:

Bailout the airlines and their rank-and-file employees? You bet.

Bailout the CEOs and Warren Buffett [note: Buffett is a major shareholder via investments through Berkshire Hathaway]? Not a chance.

The airlines have demonstrated they're willing to accept responsbility for some of these moves. On Saturday, industry leaders said they were willing to suspend buybacks and divided payments for the life of their loans.

That's a solid move, but I don't think its enough. If airlines simply pick up where they left off when these loans are paid back, we'll be right back in this situation in the future. To me, that leaves two -- if unsavory -- options:

  • Mandate an immediate end to buybacks and dividend payments for at least 10 years, including hard caps on executive compensation. Permission needs to be sought for any major operational changes. In essence, start treating airlines as utilities.  (another point made in Hunt's article)
  • Instead of a bailout, the government agrees to buy shares of these companies at set prices, thus becoming major shareholders with the power to dictate board and management decisions.

It's not fun to play games of chicken in times of crisis. But that's the situation we've found ourselves in. Few would argue against the necessity of airlines. Fewer could reasonably argue airlines have been responsbile stewards of capital.

We need to find a solution that acknowledges both realities -- and fast.