American Airlines: Invest Or Avoid?

American Airlines stock is currently a risky investment. The stock is within a very wide and falling trend, and while this may indicate a good buying opportunity, it is expected to fall by 6.68% over the next three months. The stock is also oversold on RSI14 and has a large prediction interval from the Bollinger Band, indicating that it is a high-risk stock. Additionally, the company has a large debt load and weak profitability, and there are concerns about rising labour costs, a potential recession-induced pullback in demand, and increased competition from United Airlines. While the stock may appear cheap, it is likely a value trap.

American Airlines' profitability

American Airlines Profitability

Overview

American Airlines Group Inc. (AAL) is a major US airline that has recently returned to profitability after a challenging few years. The company's financial performance is strongly influenced by fuel prices, labour costs, consumer demand, and its ability to manage these factors through pricing and operational efficiency.

Recent Financial Performance

In the second quarter of 2024, American Airlines reported a profit of $1.34 billion, benefiting from strong ticket sales and a significant drop in jet fuel prices. This resulted in a quarterly record revenue of $14.06 billion, a 5% increase. International travel, in particular, has been a key driver of this growth.

Historical Challenges

However, it is important to note that American Airlines has faced financial challenges in recent years. During the COVID-19 pandemic, the airline industry was severely impacted, with American Airlines slashing flight schedules and experiencing a decline in revenue. The company's earnings and revenue had been weak even before the pandemic, with flat earnings per share and a 9% average decline in revenue over three years.

Debt and Liquidity

American Airlines has a substantial debt burden, with $37 billion in debt and nearly $8 billion in lease liabilities as of the third quarter of 2024. While the company has made progress in reducing debt, this has come at the cost of liquidity, with a similar decline in unrestricted cash and investments. To meet its target of reducing total debt by $15 billion by 2025, American Airlines will need to generate significant free cash flow.

Future Prospects

Analysts expect American Airlines to remain profitable in the third quarter of 2024, although at a lower margin than the second quarter. The company's ability to manage costs, particularly labour expenses, and maintain strong consumer demand will be crucial for its financial performance.

In summary, American Airlines has demonstrated improved profitability in recent quarters, driven by strong travel demand and favourable fuel prices. However, the company continues to face challenges related to its significant debt burden and cost management. While there are positive signs, potential investors should carefully consider these factors and stay updated with the company's progress in addressing them.

The impact of high fuel prices

The Russia-Ukraine conflict has sent oil prices soaring due to sanctions on Russian oil and gas, causing fuel costs to rise by 140% year-on-year in North America and 126% in Europe. This has resulted in an approximate $8 billion increase in annual fuel costs for a major US airline. Consequently, airlines have been forced to pass on some of these costs to consumers, leading to a 20% increase in ticket prices compared to 2019.

High fuel prices can also lead to greater capacity discipline in the industry. The marginal cost of operating flights increases with higher fuel prices, incentivising airlines to be more disciplined in their capacity deployment and route profitability assessments. This can ultimately lead to improved industry economics and profitability.

However, the impact of high fuel prices can be mitigated by strategies such as fuel hedging, where airlines agree to buy jet fuel at a set price in advance to protect themselves from sudden price spikes. For instance, Air France-KLM hedged 63% of its fuel bills for Q2 at $90, while Lufthansa secured its entire 2022 supply for just $63 per barrel.

American Airlines' debt

American Airlines Group Inc. is the largest airline internationally. Its long-term debt for the quarter ending March 31, 2024, was $28.228 billion, a 10.63% decline year-over-year. The company's long-term debt has been decreasing since 2022, when it was $32.389 billion.

In March 2023, the company announced it was halfway through its biggest-ever debt-cutting plan, aiming to reduce its debt by $15 billion. The new chief financial officer has stated that the plan is on track, and the company is focused on a more balanced capital approach.

American Airlines ended the third quarter of 2022 with $37 billion of debt, plus nearly $8 billion of lease liabilities. The company's CFO, Derek Kerr, noted that total debt had peaked a year earlier and had declined by $5.2 billion since then. However, liquidity has also declined by a similar amount, as American Airlines has used excess cash to repay some of its debt.

As of June 2022, American Airlines still had $12.5 billion of unrestricted cash and investments, which could be used for additional debt repayments. However, the company needs to generate a meaningful amount of free cash flow to meet its 2025 debt reduction target. While American Airlines plans to keep capital expenditures modest in 2023, projected spending on aircraft and engines is expected to increase in 2024 and 2025, giving the company a brief window to generate the cash flow it needs.

The company's debt has been cited as a reason for investors to be cautious about buying American Airlines stock. With over $22 billion of debt maturing between 2024 and the end of 2026, American Airlines is in a challenging position.

The impact of rising labour costs

Rising labour costs can put pressure on margins and lead to higher airfares. To mitigate the impact of rising labour costs, airlines can improve efficiency by investing in better consumer technology, simplifying their business operations, increasing utilisation of assets, outsourcing non-core activities, measuring profits beyond just flight revenue, and regularly reviewing expenses.

American Airlines, in particular, has a large debt load and weak profitability. The company's enormous debt load of $37 billion, along with nearly $8 billion in lease liabilities, makes it vulnerable to any missteps in managing its finances. With over $22 billion in debt maturing between 2024 and 2026, American Airlines needs to generate significant free cash flow to meet its debt reduction targets.

In summary, rising labour costs can have a significant impact on the financial performance of airlines, and American Airlines may struggle to offset these costs due to its existing financial challenges.

The impact of a potential recession

However, it is worth noting that discount airlines may be able to survive and even thrive during economic recessions. They tend to operate on routes with high passenger demand and have a lean cost structure, making them attractive options for cost-conscious travellers and businesses.

American Airlines, in particular, has been facing challenges even before the potential recession. The company's earnings and revenue have been weak, with flat earnings per share and declining revenue over the last three years. The COVID-19 pandemic and the Boeing 737 Max grounding also impacted their business significantly. While they have received bailouts and are showing some signs of recovery, their stock is currently not considered a buy by analysts.

In the event of a recession, American Airlines may experience further difficulties. A recession could lead to a decrease in demand for air travel, impacting their revenue and profitability. Additionally, they have a significant debt load, with a total debt of $37 billion and lease liabilities of $8 billion. Their high debt could make it challenging for the company to navigate through economic downturns.

Overall, while American Airlines has returned to profitability and is working on reducing its debt, a potential recession could have a negative impact on their business and stock performance. It is important for investors to carefully consider the risks associated with investing in the airline industry, especially during uncertain economic times.

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