Last year, American Airlines (NASDAQ:AAL) was the most vulnerable of the airline stocks. However, with the vaccines rolling out, AAL stock is getting an outsized reaction, as are its peers.
The airline industry has been hobbled by the effects of the novel coronavirus pandemic. It will not bounce back with nearly as much vigor as people seem to think.
The reality is AAL stock is overvalued, factoring in its massive debt load and the industry’s cut-throat competition.
AAL stock has been rallying in the past three months, and is up more than 57% year-to-date. Investor interest in recovery plays and the industry’s optimism with the approval of the vaccine are pushing airline stocks higher.
This is strange considering how AAL stock now trades higher than its price just before the pandemic. Travel numbers are expected to pick up in the third and fourth quarters, but it will take a long time before they return to pre-pandemic levels.
Therefore, AAL stock’s price results from the market’s overreaction, which further reduces its attractiveness to investors at this time.
Massive Debt Burden and AAL Stock
The pandemic exacerbated American’s debt problem to the point where shareholders were concerned about its solvency. Despite its best efforts, the company’s net debt stands at roughly $30 billion. It is paying more than a billion dollars in debt servicing, which is likely to have crippling long-term effects on its operations.
In all fairness, it has done well to reduce its cash burn, which went as high as $100 million per day last year. However, its cash burn now averages $30 million per day, which amounts to almost a staggering $11 billion a year.
The federal government’s support through the CARES Act has been nothing short of a blessing. It provided payroll grants which covered the bulk of airline labor costs from April to September of 2020.
Despite the assistance and the cost control measures, American needs upwards of $8 billion to return to pre-pandemic debt levels. Additionally, the share count has shot up to 640 million as of December from 423 million a year ago.
That has naturally resulted in massive dilution for shareholders, which complicates earnings recovery even more. The recent price movement and the higher share count have taken American’s market capitalization beyond pre-pandemic levels.
Challenges Ahead
Despite the progress in vaccine distribution, the going will be extremely challenging, especially for airlines. On a positive note, the 737 MAX is back in commission, and the airliner’s fleet streamlining efforts could result in higher profitability.
The grounding of the 737 MAX cost American more than $500 million in pre-tax income in 2019.
The competition is growing, though, especially with existing airlines expanding their route maps to increase productivity. For instance, Southwest Airlines (NYSE:LUV) announced that it would fly to 17 new destinations. JetBlue (NYSE:JBLU) plans to launch flights to London and also introduced premium flights to Los Angeles last month. These areas have proven to be lucrative for American in the past.
Interest expenses continue to rise for the company, and as per the latest quarter, the run rates at $1.5 billion compared to $1.1 billion in 2019. American plans to raise $7.5 million of new debt, which is backed by its loyalty program. This will further weaken its margins down the line.
Bottom Line on AAL Stock
AAL stock has been rallying hard in the past few months as a potential airline recovery play. That couldn’t be further from the truth with the airliner mired in a debt-trap.
Though it has shown progress in controlling its costs, there is a long way to go before the company can return to pre-pandemic debt levels. Additionally, the competition is heating up in the sector with its peers looking to one-up on each other in the post-pandemic world.
Therefore, AAL stock is not the recovery play you should be considering.
On the date of publication, Muslim Farooque did not have (either directly or indirectly) any positions in the securities mentioned in this article.