Last week, three of the top four U.S. airlines reported their first-quarter earnings results, giving investors a better look at the impact of the COVID-19 pandemic on this uniquely vulnerable sector. American Airlines (AAL -2.18%), Southwest Airlines (LUV -0.54%), and United Airlines (UAL -2.52%) all lost money and expect to incur even greater losses in the second quarter.
That said, the scale of the companies' losses differed quite dramatically. Furthermore, the carriers have vastly different financial resources. Southwest Airlines measures up as best-of-breed along both dimensions, while American Airlines is in particularly bad shape. Bargain-hunting investors looking to snap up beaten-down airline stocks in the hope of a long-term recovery should stick to higher-quality companies like Southwest, while steering clear of weaker competitors like American -- and even United.
Tolerable cash burn and a fortress balance sheet
While air travel demand fell off a cliff in March, Southwest Airlines benefited from strong performance in January and February. As a result, it posted a modest adjusted net loss of $77 million for the first quarter, on revenue of $4.2 billion: down 18% year over year.
Of course, results will get a lot worse in the second quarter. Southwest expects revenue to plunge 90% to 95% year over year in April and May. However, the company has reduced average daily cash expenditures for the quarter to a range of $30 million to $35 million. That would limit quarterly cash burn to around $3 billion even with zero net cash inflows (i.e., if new cash bookings were fully offset by refunds).
Southwest Airlines' revenue has fallen to nearly zero this month. Image source: Southwest Airlines.
Fortunately, Southwest has built up a fortress balance sheet. At the end of the first quarter, it had $5.5 billion of cash and short-term investments and just $6.3 billion of debt. Between then and April 24, the carrier received half of its CARES Act payroll support funds (over $1.6 billion) and drew down an additional $2.7 billion on its 364-day term loan. As a result, the company had over $9 billion of cash on hand by the time of its earnings report last week.
Southwest isn't stopping, either. Last week, it brought in nearly $4 billion by selling stock and convertible debt. (That amount could increase by 15%, depending on demand.) It will also receive the remaining $1.6 billion of CARES Act payroll funds by July. Finally, Southwest is putting the finishing touches on a $2 billion debt offering to refinance some of its short-term borrowings.
The net result is that even with no additional capital-raising moves and a very modest recovery in demand, Southwest should end the third quarter with at least $10 billion of cash and investments. That will give the low-cost airline a nice cash cushion no matter how fast demand recovers and enable it to start repaying debt and investing for the future in 2021.
A smoking, radiating ruin
By contrast, American Airlines posted a massive $1.1 billion adjusted net loss last quarter, on revenue of $8.5 billion, down 20% year over year. It also expects to burn an average of $70 million of cash a day during the second quarter, although that should recede to $50 million by the end of the period.
American Airlines is burning through its cash rapidly. Image source: American Airlines.
Meanwhile, American's balance sheet is in tatters. It ended Q1 with just $6.8 billion of liquidity: barely more than Southwest, despite burning cash twice as fast. It also had more than $34 billion of debt and lease liabilities.
American did say that it expects to have over $11 billion of liquidity by the end of the second quarter. However, it's relying on government grants and loans to get there: $4.8 billion of the $5.8 billion in payroll support it will receive, as well as an additional $4.75 billion secured loan available under the CARES Act.
The problem is that unless demand recovers in a meaningful way for the second half of 2020, American could burn through another $5 billion or more by year-end. That would leave it with little room for error entering 2021, as it doesn't have much collateral to offer investors for future borrowings (except potentially its loyalty program). And even if demand does recover enough to enable American to fight its way back to cash breakeven next year, the company will be weighed down by more than $40 billion of debt and lease liabilities.
The in-between case
United Airlines is clearly in better shape than American, but it is still far from matching Southwest's financial strength. United reported an adjusted net loss of $639 million for the first quarter, on a 17% drop in revenue to $8 billion. Moreover, despite being only slightly smaller than American Airlines, it expects to burn just $40 million to $45 million a day on average during the second quarter.
That said, the company ended Q1 with a mere $5.2 billion of cash and investments, plus $2 billion of credit-line availability, offset by $23.4 billion of debt and lease liabilities. Since the beginning of April, United has raised about $1 billion from a stock offering and issued another $250 million of debt. It will also receive about $4.2 billion of its $5 billion of CARES Act payroll support this quarter.
As a result, United Airlines is likely to end Q2 with close to $9 billion of liquidity, not counting the $4.5 billion in CARES Act loans it is eligible for. Considering the progress it has already made on slowing its cash burn, United faces far less risk of a 2021 cash crunch than American Airlines, even if air travel demand recovers haltingly. However, it is likely to have around $30 billion of debt by year-end, and the carrier will need to spend heavily on capex over the next decade to upgrade its aging fleet.
There's a clear choice
Southwest Airlines stock hasn't fallen quite as much as shares of American Airlines and United Airlines during 2020. That said, all three stocks have been marked down substantially because of the massive earnings and cash-flow pressure they face.
Southwest Airlines, American Airlines, and United Airlines Stock Performance, data by YCharts.
The sharper declines in American Airlines stock and United Airlines stock aren't necessarily the prelude to a big rebound. Both companies have significantly lower profit margins than Southwest under normal conditions. Last year, United's adjusted pre-tax margin was 9% and American's was just 6.3%. Meanwhile, Southwest's adjusted pre-tax margin exceeded 13%, even though the company faced a bigger margin headwind from the Boeing 737 MAX grounding than either of its larger peers.
Furthermore, United Airlines has heavy exposure to long-haul international routes, which are likely to experience a much slower demand recovery than the short-haul domestic routes that are Southwest's bread-and-butter. American also has significant international operations.
In short, American Airlines and United Airlines will likely take longer to return to profitability than Southwest. That makes their weak balance sheets even more problematic. High debt will depress United Airlines' value for the foreseeable future, and even raises a meaningful risk of bankruptcy for American. Southwest Airlines stock offers a far better risk-reward trade-off for long-term investors.
