June has been an extremely volatile period for American Airlines (NASDAQ:AAL) stock. Shares of the U.S. airline giant soared in the first week of the month, including a bizarre 41% surge on June 4. The stock then gave up some of its gains over the past week, plummeting 29% over a three-day period from Tuesday to Thursday.
American Airlines stock was on the move again on Friday, following a bullish investor update. The shares rallied 16% to end the week at $16.74.
In contrast to the prior week's rally, at least there was some meaningful positive news to justify American Airlines stock's big gain on Friday. Nevertheless, investors appear to be too optimistic about the company's medium- and long-term prospects.
Finally, a real sign of improvement
The massive rally in American Airlines stock on June 4 was sparked by a press release indicating that the carrier planned to restore 55% of its normal domestic schedule in July: up from just 20% to 25% in May. This seemed to confirm a growing belief among investors that air travel demand is rebounding rapidly from the coronavirus-induced downturn.
That said, just a week earlier, management had reiterated its guidance for the second quarter, calling for daily cash burn to average $70 million during the period (excluding payroll support funds provided under the CARES Act). This implied total cash burn of more than $6 billion in the current quarter alone. Thus, improving traffic results didn't seem to be helping the bottom line.
On Friday, American Airlines provided another investor update. The airline disclosed that its load factor improved sequentially in the first eight days of June relative to May, even as it began to restore some capacity. Management also said that net bookings have been positive since mid-May across all parts of the booking curve (i.e. both last-minute purchases and bookings for travel months from now).
Most importantly, management noted that cash burn was on track to moderate to $40 million per day in June, compared to its original estimate of $50 million per day for the final month of the quarter. That's a significant, tangible improvement -- although it means the company is still burning more than $1 billion of cash each month. Management hopes to reduce cash burn to zero by year-end.
This improved outlook was supported by the latest TSA data on passenger screenings. More than 500,000 people passed through TSA checkpoints this Thursday, compared with fewer than 400,000 just a week earlier. Passenger numbers are still down 81% year over year, but that's a big improvement from being down 96% in mid-April.
Setbacks are likely
As encouraging as the recent update was, investors shouldn't rush to buy American Airlines stock. American's management has had a tendency to be overoptimistic in recent years: in 2017 and 2018, CEO Doug Parker frequently predicted that the airline would never again lose money. That prediction obviously didn't work out too well!
In this case, an uptick in bookings for the peak summer travel season is likely driving the recent reduction in cash burn. Other airlines have observed similar booking trends but are being more cautious in projecting what that means going forward. Most airlines (including American) are waiving change fees right now, so it's still possible that customers who have booked tickets in recent days will ultimately cancel their travel plans.
More broadly, American Airlines faces two major threats to its hoped-for recovery in the months ahead. First, business travel is recovering far more slowly than leisure travel, as cash-strapped companies look to cut costs and others ban non-essential travel to limit the risk of infection among their employees. Without a stronger rebound in business travel, the recovery could falter after the summer vacation season. Furthermore, business travelers are by far the most profitable customers for legacy carriers like American.
Second, a potential "second wave" of the pandemic could drive another downturn in air travel. The number of COVID-19 cases and hospitalizations has been rising quickly in some states that reopened in early May, including Texas and North Carolina: home to American's two largest hubs. This worrisome trend could turn into a big headache for American Airlines if it continues.
Way too much debt for comfort
Even if demand does continue to improve at a steady pace, American Airlines will still exit 2020 with a massive -- and potentially unmanageable -- debt load. During the first quarter, American's debt and lease liabilities increased from $33.4 billion to $34.1 billion. Between April and July, the company plans to access over $10 billion of government funds available under the CARES Act, including $6.4 billion of loans. It also drew $2.7 billion from its credit lines in April. These moves will boost American's debt load to more than $40 billion. Additional financing may be necessary later this year to cover future cash burn.
American Airlines already had the most debt in the airline industry by far at the beginning of 2020. Its balance sheet woes appear even more acute now. Cash flow could remain weak for the next several years; meanwhile, American has nearly $10 billion of debt set to mature between 2021 and 2023.
While American Airlines stock has fallen more than 40% year to date, this has only reduced its market cap by around $5 billion. That's less than the amount of cash the company will burn through in 2020, even in a best-case scenario.
Thus, American Airlines stock is valued as if its prospects have actually improved since the beginning of this year. That is most certainly not the case. For investors who are bullish about an airline recovery, better-performing peers offer more upside with less risk.