Why Investors Revile and Deplore American Airlines
American Airlines is currently facing a monumental downhill battle in the financial realm, with investors showing their disapproval in a dramatic way. Enormous plunges in stock prices have resulted in the iconic American Airlines losing its value as a major enterprise. Standing as the 478th most valuable public enterprise in America, a grim future is in store as funding companies and investors forecast the airline achieving significantly less revenue than in the past.
The huge decline in stock prices across all four major airline carriers: American, Delta, United, and Southwest, is indicative of the forecasted decrease in earnings. The stock prices of Delta and United, despite suffering slightly lesser declines, are still more than 10% higher than their all-time low since the outbreak took place, whereas Southwest and American have plummeted even farther below their pandemic bottoms.
When it comes to resonating with the global audience, it’s important to assess the current performance and underlying causes of such a dramatic fall. Since the merger with U.S. Airways to form the world’s biggest carrier, American Airlines has struggled to maintain high profitability while accumulating an excessive amount of debt. The combination of these two factors has severely hindered its ability to reduce its debts substantially.
Fears of a dividend cut and a “material” increase in debt have weighed on American Airlines’ shares. Market analysts now project a prolonged recovery period that stretches well into 2023. Those findings are a stark indication of the investor sentiment, one that foretells American’s future as nothing but a “loser.”
Assessing the big fall since July that killed budding comebackTwo negatives account for the sudden retreat, says Savi Syth of Raymond James. The first is the 40% June to September run-up in jet fuel, a line item that even before the jump accounted for around one-fourth of operating costs. The rise explains why stocks began dropping in the summer while traffic was still strong.
That hit, says Syth, disproportionately penalizes American and Southwest somewhat versus Delta and especially compared to United. American tilts more towards the domestic market, as well as Latin America, than its two network rivals that offer more extensive service to Europe and Asia. Hence, its average flights are shorter, and the fewer miles covered, the higher the fuel expense per passenger, since such a high proportion of burn happens at takeoff. In addition, Delta and United are flying a greater mix of wide body aircraft that use less fuel per passenger. (Southwest has the greatest exposure to fuel costs since its only foreign destinations are relatively nearby places in Central America and the Caribbean.)
Story continuesThe second downer: softening sales going into the fall. “Last year, because of all the pent-up demand for travel, the vacation season lasted well into October,” explains Syth. “This year, it’s returned to the traditional seasonal pattern, so that we’ve seen a slowdown versus the extremely high levels at this time last year.” Delta and United are also benefiting more from global trends than American, as traffic to Europe and Asia remains robust while the U.S. fades.
For all four majors, the recent collapse in stock prices is flashing an extreme signal: Investors foresee the carriers’ earning a lot less in the years ahead than when they were selling at well above today’s levels as the recovery from the Great Financial Crisis gathered speed from 2014 to 2019, or even in June of this year.
But of the Big Four, American’s valuation is the lowest by a wide margin, meaning that investors wager that it will do far, far worse going forward than its beaten-down peers. The market caps for United ($11.1 billion) and Southwest ($13.3 billion) exceed American’s $7.1 billion by 54% and 85% respectively, and Delta’s $20 is almost three-fold bigger.
That American’s worth lags even the pummeled numbers for its rivals is especially shocking because measured in annual revenue, it’s about the same size as Delta and United in the low-$50 billion range, and collects twice the fares of Southwest. In fact, its lowly standing sits in stark contrast with its role as a centerpiece of global air travel—and even its current financial performance. The colossus of Fort Worth towers as the world’s largest carrier, measured in fleet size, daily flights, and passengers carried; last year, nearly two hundred million customers filled its seats.
Though the COVID crisis left its deepest scars on American, the airline’s rebounded sufficiently to generate well above the profit dollars needed to pay its creditors. Hence, the chance it will fall into bankruptcy, as it did in 2011, appear minimal. Indeed, following Q2 earnings, Fitch and S&P awarded American double upgrades and Moody’s raised its status one notch. All the agencies view American as motoring in recovery mode. In a note earlier this year, Fisk cited prospects for “improved profitability” and a position of “solid liquidity.”
“For all four airlines, that valuations have fallen to around the COVID period’s or even below in the cases of Southwest and American look bonkers,” says Syth. “The markets are forecasting that 2023 will represent peak earnings, and see a descent from there.” And for investors, the most ghoulish and repelling of the group, the “loser” destined to at best bump along as revenues barely exceed expenses, is American.
Given that U.S. travelers rely on the stalwart for around one-quarter of their air travel, it’s important to examine American’s current financial performance, and assess whether the odds that it will get much worse from here are really as high as the market’s dreariest of dreary judgment.
American’s twin problems: Weak cash generation, and excessive debt
Since its U.S. Airways tie-up that in 2013 created the world’s biggest carrier, American has been both the least lucrative of the four majors, and accumulated the most debt. And the combination limits its ability to reduce the big pile of borrowings. A metric called cash operating return on assets, or COROA, is an excellent yardstick for the returns American garners from marshaling its planes, gates, maintenance hubs and all other investments. COROA is the brainchild of Jack Ciesielski, one of America’s top accountants. To remove the effects of leverage and taxes, COROA starts with cash from operations and adds back interest and taxes paid in cash. That number is the numerator. The denominator is balance sheet assets plus accumulated depreciation and amortization. It represents all the capital parked in the business used to generate those cash flows. COROA displays how many dollars a company collects from all the dollars ever plowed into the business as it now exists, regardless of its debt load or tax burden.
In 2022, American achieved $3.95 billion in “operating cash flow,” pre cash interest and taxes, on $85 billion in assets, for a return of 4.7%. That’s down from $5.7 billion and 8.5% in 2017, though it’s a big improvement over the 2.7% margin of 2021. The basic issue: American kept earning less on a growing asset base. By contrast, Southwest recorded COROA of 7.6% last year, and both Delta and United hit 8.7%, almost twice American’s result and numbers exceeding those half-a-decade back.
While cash flow trickled, American borrowed heavily for two purposes, repurchasing shares and buying new planes. Following the merger, the leadership saw their newly-formed giant as extremely undervalued, and spent a staggering $12 billion on buybacks between 2014 and 2019 in anticipation that big operating improvements would drive its stock far higher. American also spent $30 billion in the same period replacing its aging roster of jets, adding over 300 of the narrow body Boeing 737-800 Max, a gambit that amassed the youngest fleet among the big four. “All the spending that was happening while American was still merging the two systems contrasted with the much more measured, conservative approach at Delta,” says Syth.
Those huge outlays imposed a mortgage on American’s future. In 2014, it owed $8.1 billion in net debt (defined as long-term borrowings plus capital leases, minus available cash). By the close of 2019, the burden had ballooned to almost $25 billion. Due to losses not covered by the huge federal aid package…
