American Airlines Group (NASDAQ:AAL) and other airlines have been hit hard by the COVID-19 pandemic, with travel demand reduced to a trickle. American lost $2.2 billion in the first quarter and expects second-quarter results to be worse.
The pandemic has brought to a sudden end a decade-long period of expansion by the airlines and has raised questions about the industry's long-term future. The outlook is so bleak that Warren Buffett, who famously preaches investors should be greedy when others are fearful, joined the stampede heading for the exits by liquidating Berkshire Hathaway's massive stakes in American and other airlines.
Shares of American have lost 65% of their value year to date. As dangerous as it has been historically to go against Buffett, the stock is almost certainly set up to go higher in the quarters to come if the company is able to survive the pandemic crisis. The question is, will it survive?
Here is a look at American's prospects to determine whether it is a good buy today.
Shrinking to profitability
American, like its peers, is expecting a prolonged downturn in travel demand. Domestic leisure travel is likely to be the first to rebound, in part because it is the most easily stimulated by fare drops. It is also typically the lowest-margin business for airlines.
Large corporate accounts, where airlines typically make a substantial portion of their profits, are likely to come back well after tourists and non-corporate business travel. And international networks might never fully recover to pre-pandemic highs, in part because of shifting demand and in part because American and other large airlines are likely to take a conservative approach to growth and lean on foreign partners to help cover the globe.
American, as part of the Oneworld alliance with British Airways, Spain's Iberia, Japan Airlines, and Qantas of Australia, among others, is well-positioned to offer customers global access. But if the industry is increasingly splitting international profits with foreign partners in years to come, it will crimp long-term earnings growth to some extent.
On the domestic front, American is preparing to shrink. Chief Financial Officer Derek Kerr during a virtual presentation to investors on May 19 said the carrier is "doing everything we can" to "right-size the airline from a cost perspective to make sure what we fly next year is cash positive."
American expects to cut operating costs and capital expenditures by $12 billion in 2020. The airline has retired four aircraft types and has brought system capacity down 80% in April and May and 70% for June. Depending on booking trends in late summer/early Fall, Kerr's comments suggest layoffs and more plane retirements could be on the horizon.
An ugly balance sheet, but enough cash to survive
American expects to have $11 billion in total liquidity by the end of 2020 and could try to raise additional capital in the third quarter backed by their aircraft or landing rights at what are typically congested airports.
The airline said during its first-quarter earnings release that it recently had its unencumbered assets appraised and believes it has $10 billion or more that can be used as collateral. American for now is focused on finalizing a $4.75 billion loan from the U.S. Treasury authorized under the CARES Act stimulus package, but expects to seek other options once its talks with the government are complete.
American as of quarter's end had $21.6 billion in long-term debt and total liabilities of more than $40 billion when factoring in pension obligations, operating leases, its loyalty program, and other liabilities. But the company has a lot of wiggle room to manage through that debt. American has a $1 billion, 364-day term loan facility that will need to be refinanced by March 2021, but beyond that has no non-aircraft debt maturities for more than 24 months.
Coming into 2020, American had expected significant free cash flow this year that was going to go toward paying down that industry-high debt load. That's now off the table, but if American can succeed in shrinking to profitability, as Kerr suggests, it is likely to plow whatever profits it generates into debt repayment.
Should you buy American?
Boeing CEO David Calhoun earlier this month turned heads when he said a major airline would "most likely" go out of business in 2020. He's since walked back those comments, but among the major airlines, American -- due to its debt and its late start to an industrywide period of restructuring -- was the carrier that sprung to mind when the statement was made.
I'm hopeful that all of the major airlines, American included, can survive without liquidity issues. But the airline's fate is largely based on the answers to questions about how long the pandemic will last, will there be a second wave, and what the post-pandemic economy will look like -- questions no one knows the answer to right now.
American shares are a lot more affordable than they were just a few months ago. And the airline is cheaper than any of the three other large U.S. carriers in terms of its multiple to sales and earnings. But given the way airline stocks have been knocked down by the pandemic, the entire sector is cheap, assuming traffic returns.
I believe American's management team is top notch, and in all but the worst-case scenarios, I expect them to remain airborne through this crisis. But given the uncertainty, and the valuations throughout the industry, I'd advise buying other airlines that would appear to have a clearer path forward.
For now, at least, American Airlines is not a stock I'd recommend buying.