On Thursday, American Airlines (AAL -1.35%) reported a slightly smaller quarterly loss than analysts had expected. But make no mistake: American's third-quarter results were easily the worst of any major U.S. airline. The carrier expects to lose more money than any of its competitors in the fourth quarter, too. The lesson for investors is clear: steer clear of this troubled company.
Another bad quarter
Three months ago, many airlines expected to be profitable during the third quarter, thanks to a strong rebound in summer leisure travel. However, despite the improving demand environment, American Airlines never expected to turn a profit in Q3, mainly due to its high cost structure and crippling interest costs. Management's initial guidance called for American to log an adjusted pre-tax margin between -3% and -7%, with revenue down 20% from the third quarter of 2019.
Adding to the airline's woes, demand stalled out near the beginning of August as U.S. COVID-19 case numbers surged. In early September, American Airlines slashed its quarterly forecast, saying that it expected revenue to fall 24% to 28% from Q3 2019, leading to an adjusted pre-tax margin between -10% and -14%.
Ultimately, American's third-quarter revenue totaled $9 billion, down 25% from two years ago. The company recorded an adjusted pre-tax loss of $833 million, putting its adjusted pre-tax margin at -9.3%: better than its most recent forecast but still considerably worse than its initial quarterly guidance. (American did earn a $169 million profit under generally accepted accounting principles, but that included a substantial benefit from the final batch of federal payroll support grants.)
Image source: American Airlines.
To put American's results in context, key rival Delta Air Lines (DAL 1.27%) reported a modest Q3 adjusted profit earlier this month. Meanwhile, United Airlines (UAL -0.36%) posted a smaller adjusted pre-tax loss of $473 million, which translated to a -6.1% adjusted pre-tax margin.
The fourth quarter will be worse
American Airlines' financial results will likely deteriorate further in the fourth quarter, which tends to be a seasonally weaker period for airlines. On Thursday, the company said that it expects revenue to fall 20% compared to Q4 2019 on 11% to 13% less capacity. Adding to the earnings pressure, nonfuel unit costs are on pace to rise 8% to 10% over that period and fuel prices could spike by roughly 20% compared to the $2.05 per gallon that American paid two years ago.
Based on these projections, management expects American Airlines to report an awful -16% to -18% adjusted pre-tax margin this quarter. That implies a pre-tax loss of roughly $1.5 billion.
Unless American beats these targets by a country mile, its Q4 financial results will lag those of Delta and United again. United Airlines' guidance implies an adjusted pre-tax loss of around $1 billion this quarter, and Delta Air Lines in turn will post a much smaller loss than United.
Massive risk and little upside
Analysts currently expect most U.S. airlines to earn substantial profits next year (assuming no additional pandemic-related setbacks). By contrast, the analyst consensus currently calls for American Airlines to earn a negligible profit in 2022.
Image source: American Airlines.
American Airlines' weak balance sheet makes its persistently weak profitability particularly dangerous. American ended last quarter with $38.3 billion of debt, plus around $15 billion of pension and lease liabilities. Moreover, the airline used over $1.7 billion of cash in its operations last quarter. Based on its weak Q4 earnings forecast, it will likely burn even more cash this quarter.
To be fair, American ended last quarter with $14.5 billion of unrestricted cash and investments, giving it time to turn things around. However, the company has nearly $20 billion of debt maturing between now and the end of 2025. If American Airlines still isn't generating meaningful earnings and cash flow within a couple of years, it could struggle to repay or refinance all that debt.
That creates substantial risk for investors. On the flip side, American Airlines' fully diluted market cap has rebounded beyond its January 2020 (i.e., pre-pandemic) level. Thus, investors aren't getting a discount for bearing this risk, making American Airlines stock extremely unattractive.
