American Airlines Stock Likely To Grind Lower On U-Shape Recovery

Stocks to sell

Airline stocks have been in news with the industry among the worst hit due to the crisis triggered by the novel coronavirus. With most airline stocks plunging, there is ample discussion on value buys in the industry. American Airlines (NASDAQ:AAL) stock has declined by 64% from fiscal year 2020 highs and currently trades at $11.

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AAL stock has shown some resilience around $10 levels, so it might seem that the stock has bottomed out. However, I believe that the stock will trend lower in coming quarters.

Before discussing points specific to American Airlines, it’s important to point out that industry recovery is not coming anytime soon. Airports Council International believes that passenger traffic is unlikely to recover to pre-coronavirus levels until the end of FY2021.

Fitch Ratings has a similar view with full rebound to 2019 level passenger traffic only likely by FY2022 and beyond. This seems very likely as travelers will be cautious even after the lockdown.

A near-term conclusion on the industry is that companies will face at least six to eight quarters of challenging times. Even as gradual recovery might start towards the end of the year.

The International Air Transport Association estimates that the coronavirus pandemic could cost the airline industry up to $314 billion. That’s three times worse than the “worst case scenario” provided by the association five weeks earlier. Clearly, this is a rapidly evolving situation with high uncertainty. It makes sense to avoid AAL stock considering the worsening industry outlook.

The Liquidity Perspective

The U.S. airline companies have been guilty of spending nearly 96% of their free cash flows between 2010 and 2019 for buybacks. American Airlines has been among the most aggressive in terms of buying back shares. The company repurchased more than $12.5 billion of its share during the given period resulting in negative cumulative free cash flows.

As of December 2019, American Airlines reported cash and short-term investments of $3.8 billion. However, with $3.2 billion in undrawn credit facility, the company’s total liquidity was $7 billion.

In addition, the U.S. Department of the Treasury has approved $5.8 billion in financial assistance from the Payroll Support Program. This will help the company in paying salaries and benefits. American Airlines has also applied for an additional loan of $4.75 billion from the U.S. Department of the Treasury.

Therefore, the company has ample liquidity support for the current year. As a positive, with no debt maturity until FY2022, the company has no refinancing pressure.

However, its worth noting that United Airlines (NASDAQ:UAL) reported $2.1 billion in losses for the first quarter of 2020. The company is also seeking further federal aid. The key point here is that cash burn can be significant in the coming quarters.

I expect American Airlines to be burdened with federal loan in the next 12-18 months. With $10 billion in unencumbered assets, securing additional debt might not be a concern. However, credit metrics will worsen for the company. This will translate into AAL stock trending lower.

From a credit perspective, the company has $5.3 billion in capital expenditure through FY2021. Further guidance on this will provide insights on the extent of leveraging that likely for American Airlines.

My Concluding Views on AAL Stock

Amidst the gloom, decline in fuel price is likely to result in cost savings of $3 billion for the year. This positive is completely overshadowed by multiple concerns. Even for the next year, its likely that fuel price will remain subdued and translate into cost saving.

For now, the main focus is on when the coronavirus is contained and the lockdown is lifted. Furthermore, overcautious travellers can extend the pain for the industry even after the virus is contained.

Therefore, it makes sense to remain in the side-lines. Multiple concerns are likely to keep AAL stock depressed. In particular, I expect multiple credit rating downgrades in the coming quarters. A weak credit profile will also impact equity prices.

Faisal Humayun is a senior research analyst with 12 years of industry experience in the field of credit research, equity research and financial modeling. Faisal has authored over 1,500 stock-specific articles with a focus on the technology, energy and commodities sector. As of this writing, he did not hold a position in any of the aforementioned securities.

Faisal Humayun is a senior research analyst with 12 years of industry experience in the field of credit research, equity research and financial modeling. Faisal has authored over 1,500 stock-specific articles with a focus on the technology, energy and commodities sector. As of this writing, he did not hold a position in any of the aforementioned securities.

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