At the end of March, United Airlines (UAL 1.59%) had a little over $7 billion of liquidity. Considering the rate at which airlines have been burning cash in recent months, that didn't look like nearly enough to survive the COVID-19 pandemic.
Investors no longer have to worry about United Airlines running out of cash, though. The legacy airline is poised to finalize an enormous new debt facility backed by its MileagePlus loyalty program this week. That, along with other capital-raising initiatives, will give United more than enough liquidity to survive the COVID-19 crisis. However, the airline will end up weighed down by a massive debt load, making the stock unattractive even at its current marked-down price.
United addresses liquidity concerns
In early May, United Airlines canceled a $2.25 billion debt offering that would have been backed by older aircraft. Due to the weak quality of the collateral, investors were demanding double-digit interest rates, which was more than United was willing to pay. But while walking away from the deal made sense, it meant that the company needed to find alternative funding sources sooner rather than later.
Eventually, United decided to offer its MileagePlus loyalty program as collateral. This allowed the airline to raise a lot of cash at a much lower interest rate than it would have paid for the aircraft-backed debt it had planned to issue in early March.
On Thursday, United expects to issue $3.8 billion of secured debt (backed by MileagePlus) that will be due in 2027 and carry a 6.5% interest rate. At the same time, the MileagePlus subsidiary will enter into a $3 billion term loan facility. The total financing package value of $6.8 billion exceeded the $5 billion that United initially planned to raise.
Image source: United Airlines.
Back when United Airlines expected to raise $5 billion backed by its loyalty program, the company estimated that the new financing would enable it to end the third quarter with at least $17 billion of liquidity. (The plan also called for drawing all $9.5 billion of available federal payroll support grants and subsidized loans.) After upsizing the MileagePlus debt offering, it now appears that United should have around $19 billion -- and possibly more -- of liquidity by the end of September: $17 billion of cash and $2 billion of availability on its credit line.
A whole lot of debt
On a pro forma basis, accounting for all of United's recent and upcoming capital-raising activity, the company has about $32 billion of debt and lease liabilities. That's a big increase from $20.5 billion at the beginning of the year. Lease liabilities could increase by another $2 billion or so by year-end due to new aircraft that will be delivered under sale-leaseback deals.
Of course, much of this extra debt will be offset by excess cash on United's balance sheet -- for now. However, United is likely to continue burning cash in the fourth quarter of 2020 and into 2021. While domestic air travel volume has increased significantly since bottoming out in mid-April, a recent surge in COVID-19 cases in many states could nip the nascent air travel recovery in the bud. Importantly, with COVID-19 still circulating widely, business travel is likely to remain depressed for the foreseeable future.
As of March 31, United had just over $4 billion of debt maturing within 12 months. Assuming it repays that debt when it matures, debt and lease liabilities would moderate to around $30 billion by March 31, 2021. However, even if daily cash burn slows from an estimated $30 million this quarter to an average of $15 million or $20 million over the following two quarters, United's cash balance would recede to around $10 billion by next March.
This is still more cash than United would need under normal circumstances. If cash flow turns positive again next spring, the airline would be able to continue paying down some debt with excess cash. Nevertheless, debt isn't going to get back to pre-coronavirus levels anytime soon. Meanwhile, United's earnings power could remain depressed for years, due to the airline's heavy reliance on long-haul travel and business travel in competitive markets.
There are better options for investors
United's recent financing activity virtually eliminates near-term bankruptcy risk. However, just because the company won't go bankrupt anytime soon doesn't make United Airlines a good stock.
United Airlines has one of the oldest fleets among major airlines today. Entering 2020, it had $26.7 billion of future capex commitments, mainly for aircraft to be delivered between 2020 and 2030. That represents only part of United's capex requirements for the next decade. Between its high debt, high capex needs, and what will likely be weak near-term cash flow, there may be very little cash available to be returned to shareholders over the next 10 years. That makes United Airlines stock a bet on high profitability in the very distant future. Considering the risk inherent in the airline industry, that may not be a great bet to make.
