No-moat-rated American Airlines (AAL) reported a grueling second quarter, as the firm continues to operate by the playbook of raising cash and conserving cash to survive a depressed operating environment. We are reducing our fair value estimate to $14.50 per share from $15, and we remind investors we think that American’s considerable financial leverage widens the dispersion of potential equity values relative to peer airlines.
Revenue was down roughly 86%, which modestly outperformed peers due to the firm’s strategy of shrinking capacity less than other airlines to potentially capture additional market share as air traffic recovers. American ran at about 25% of 2019 capacity, while peer legacies ran closer to 10%-15%. While we’ve commended peer carriers with better balance sheets that have pursued a similar strategy, we think that American’s $50 billion of debt and purchase obligations increase the risk of needing to return to capital markets (which may not be welcoming) if passenger traffic deteriorates over the next few months, as operating more flights inherently increases variable costs. On the other hand, American may not be able to service its debt burden if it misses out on the recovery, so the firm may be backed into a corner. To American’s credit, it achieved a peer-leading 42.3% load factor, but we note that American is also centered in the Sunbelt, which was less affected by the pandemic during the second quarter.
Excluding the CARES Act and fuel costs, American cut operating expenses by about 35%, less than peers, though this is partially due to the firm running more flights and incurring more variable costs. The firm hopes to return to being cash-positive in 2021. While we’re pricing in a COVID-19 vaccine being broadly available by mid-2021, we do not think the firm will be able to post an annual operating profit in 2021 as we think losses in the first half would overshadow any potential operating profit in the second half.
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