It’s difficult to imagine a major company, large or little, that investors detest more than American Airlines. Its stock is currently hovering around the same very low levels as it was at the worst of the COVID crisis, when the world’s fleets were grounded. American’s market value has plummeted to a pitiful $7.1 billion as of October 27, a sum so diminished that this renowned brand now sputters as just America’s 478th most valuable public corporation. The company’s shares have plunged almost 90% since peaking in early 2018. To put it another way, the people and money that control the equity markets have a very pessimistic outlook for the future of the United States, one that is so dire that it lends new meaning to the phrase “diminished expectations.”
Indeed, compared to when COVID lowered the hammer, investors are now significantly more negative about the future of all the big airlines. Stocks of the Big Four—American, Delta, United, and Southwest—began to rise sharply in March of this year, stoking expectations that they would finally emerge from their three-year slump. The lever: A spike in “revenge” travel in the spring and summer increased reservations to levels that even surpassed the stellar 2019 volumes.
The rebound was not sustained. Share prices began a synchronised decline by July, which has hardly stopped. Southwest and American are the most damaged regions in the current recession. From the beginning of July, both have decreased by almost 38% as of October 27’s market closing. Southwest, harmed by out-of-date systems that compromised its historical dependability, is selling even lower than American, while United and Delta have had somewhat smaller drops and are still hanging over 10% above their pandemic lows when the epidemic started. Shares of all four of the Big Four are now trading between 2012 and 2013.
Raymond James’s abrupt retreat can be attributed to two unfavourable factors, according to Savi Syth. The first is the 40% increase in jet fuel from June to September, which was already a line item that contributed around 25% of operational expenses. The increase explains why, despite robust traffic, stocks started to decline in the summer. According to Syth, the hit disproportionately hurts American and Southwest more than Delta and particularly more than United. Compared to its two network competitors, who provide more wide coverage to Europe and Asia, American is more focused on its home market as well as Latin America.
Softening sales throughout the autumn is the second negative indicator. “Last year, because of all the pent-up demand for travel, the vacation season lasted well into October,” says 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.” When travel to Europe and Asia continues to grow while it declines in the United States, Delta and United are likewise profiting more from international trends than American ones.
As the recovery from the Great Financial Crisis picked up speed from 2014 to 2019, or even in June of this year, investors anticipate the carriers’ earning a lot less in the years ahead than when they were selling at well above today’s levels. This is why the recent collapse in stock prices is flashing an extreme signal for all four majors.
However, investors bet that American has the lowest value among the Big Four, indicating that it will do more worse in the future than its depreciated counterparts. United’s ($11.1 billion) and Southwest’s ($13.3 billion) market values are 54% and 85% more than American’s ($7.1 billion), respectively, while Delta’s ($20 billion) is nearly three times larger.
It is particularly surprising that American’s value behind even the severely undervalued figures for its competitors, given that, when it comes to yearly income, it is about on par with United and Delta in the low $50 billion area and collects twice as many fares as Southwest. In actuality, its humble position contrasts sharply with its central position in international aviation—and even with its present financial situation. Almost 200 million passengers boarded the colossal Fort Worth airline last year, making it the largest in the world by fleet size, daily flights, and passengers transported.
The airline recovered enough to make far more money than it took in to settle its debts with its creditors. Therefore, the likelihood that it will file for bankruptcy, like it did in 2011, seems remote. In fact, Fitch and S&P gave American double upgrades in the wake of Q2 results, while Moody’s upgraded its rating. America is seen by all the agencies as being in recovery mode. Fisk mentioned the possibility of “better profitability” and “solid liquidity” in a note from earlier in the year.
“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,” Syth states. “The markets are forecasting that 2023 will represent peak earnings, and see a descent from there.”
Due to a 2013 merger with U.S. Airways, which made it the largest airline globally, American has been the least profitable of the four majors and has taken on the greatest debt. Additionally, the combination hinders its potential to lower the large amount of debt. The cash operational return on assets, or COROA, statistic is a great way to measure how much money the United States makes from its maintenance hubs, planes, gateways, and other investments. One of the best accountants in America, Jack Ciesielski, is the creator of COROA. COROA begins with cash from operations and adds back interest and cash paid taxes to eliminate the impact of leverage and taxes. The numerator is that figure.
Balance sheet assets plus accrued depreciation and amortisation make up the denominator. It stands for all of the money that is kept in the company and utilised to produce those cash flows. Regardless of a company’s debt load or tax burden, COROA shows how much money it makes from all the money invested in it as it is today.
With $85 billion in assets, American generated $3.95 billion in “operating cash flow” in 2022 (pre-cash interest and taxes), yielding a 4.7% return. That represents a significant increase above the 2.7% margin of 2021, although it is still down from $5.7 billion and 8.5% in 2017. Fundamentally, despite an increasing wealth base, Americans continued to earn less. Southwest, on the other hand, reported COROA of 7.6% last year.
American borrowed excessively to purchase new aircraft and repurchase shares as cash flow dwindled. The leadership of the combined company believed that their newly created behemoth was incredibly cheap after the merger, and between 2014 and 2019 they bought back shares for an astounding $12 billion, hoping that significant operational gains would propel the company’s price far higher. In addition, American invested $30 billion during that time to replace its ageing fleet of aircraft, adding over 300 narrowbody Boeing 737-800 Max aircraft—a move that resulted in the airline having the youngest fleet of 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,” Syth explains.
The future of Americans was mortgaged by those enormous expenditures. Its net debt in 2014 was $8.1 billion, which is calculated by subtracting available cash from long-term borrowings and capital leases. The burden grew to about $25 billion by the end of 2019. Owing to losses that were not compensated for by the massive federal assistance package awarded during the COVID-19 crisis, U.S. borrowing increased to $29 billion in Q1 2021. Since then, as of the September quarter of this year, it has managed to bring the total down to $25.5 billion. Nonetheless, American is transporting about twice as much cargo at United and Delta, valued at around $13 billion. (Southwest’s net debt is nil.) In addition, Americans spend almost $1.5 billion in interest each year, on top of the money they get from their cash hoard.
According to Syth, a key factor behind American’s operating profits lagging “about 3 points below Delta’s and United’s” is a legacy from the U.S. Airways union. Dis-synergies were a part of the merger, she claims. “Cost reductions were not the outcome. The United States has to increase its legacy expenditures to match the already high level of its own base.” Furthermore, American suffered significant losses on flights to Asia from both Los Angeles and Chicago due to fierce competition from United and Delta, two airlines with far stronger regional presences.
However, American began implementing a bold new plan to focus capacity in the three hubs—Dallas-Fort Worth, Charlotte, Miami, and Washington-Reagan—where it currently maintains the leading positions, starting around 2018. All of the cities served by these sunbelt hubs are among the top metro areas in the country in terms of population and job growth. “It’s a strategy based on the Delta model in Atlanta where the more business you can create in the same factory, the more money you’ll make,” Syth explains. “We were excited about the approach, and it appeared to be working.” Then the epidemic hit, making Americans abandon their “doubling-down” strategy and continue to accrue debt.
American expansionism has now restarted where it is strongest and most well-protected. “They’re getting more gates in DFW and Charlotte,” Syth adds. “They are also expanding in Phoenix, where they are tied for first place with Southwest with a 35% share. Phoenix is their connecting gateway for the west coast and shown to be a fantastic destination market throughout the epidemic.” Where it was weak, American strategically forged alliances, most notably in the Northwest with Alaska Airlines, which brings travellers from the west coast and Pacific Northwest into Seattle, where they board American flights to domestic hubs like Dallas and Charlotte. (As part of the Justice Department’s lawsuit, a federal court ordered in May to end a profitable code-sharing partnership between American and JetBlue that had been in place for three years.
Putting metrics on the market’s negative perception of Americans is enlightening. Assuming that investors would want a 10% return—that is, 8% “real” returns + 2% inflation—because it is a hazardous gamble. The 8% number translates to a very low PE of around 13. Investors anticipate that American will produce future net earnings of around $500 million year (the $7.1 billion cap divided by 13), a “no growth” figure that would merely increase with inflation, based on the mild present value of $7.1 billion. Essentially, the financial elite is predicting that Americans will continue to live precariously, earning little income to settle their debts and running the danger of going into default should things become hard.
However, Americans now earn far more than that dire situation suggests. According to Syth, the carrier will make $1.6 billion this year (having already surpassed that amount during the first three quarters); earnings will decline the next year, but will increase to $2.1 billion in 2025. Remember that such sums are after interest expenses are paid.
The main risk is the start of a recession, which would reduce income and demand. Because interest still accounts for a sizable amount of American financial flows, the country continues to be the most susceptible of the Big Four. However, it seems like America can withstand everything, with the possible exception of a very severe and protracted downturn, if it just keeps going in the same direction. “There are two risks in a recession,” according to Syth.
Your spending needs remain high and your cash flow becomes scarcer. Therefore, you must borrow expensive debt or equity, which either exacerbates the crushing debt load or severely dilutes the stock price.” Or the airline files for bankruptcy because it is in such terrible shape that it is unable to secure emergency funding.
According to Syth, none of the two outcomes seem realistic for Americans, and this author concurs. By industry standards, American’s projected Capex requirements are low due to the youth of its fleet. Additionally, it is home to a significant $11.5 billion cash hoard. “Downturns are temporary, so I don’t see them needing to seek additional cash during a typical one. They often don’t persist as long as the epidemic did, according to Syth.
Perhaps the strongest argument in favour of American persistence is the fact that it leads the market in hundreds of categories with little competition. Not only will the existing airline model’s four major competitors split the market and engage in “disciplined” rivalry, but it should also ensure the carrier’s profitability and safety.