May 21, 2020

Breakingviews: American Airlines stock could be worthless

by Breakingviews.

America’s eponymous airline is a bit like its economy: struggling with lockdowns and laden with debt. But while the United States will rebound from the coronavirus pandemic, American Airlines looks less resilient. If its ability to generate profit is permanently crimped, the company’s equity, currently valued at around $4 billion, could prove worthless.

Airlines everywhere are grounded, but American entered the crisis in worse shape than rivals. Since it last emerged from bankruptcy in 2013 under Chief Executive Doug Parker, its borrowing has increased from $17 billion to $25 billion. That’s because it decided to acquire new planes, giving it a young fleet relative to peers. Even as it invested, American kept sending cash back to shareholders – some $14 billion in dividends and buybacks.

High debts – slightly increased by the interest-bearing part of the recent government bailout – make the airline’s value sensitive to its profitability. American in 2019 made $7 billion of EBITDAR, a form of profit that takes earnings before interest, tax and depreciation and adds back the cost of renting planes, which airlines do to differing degrees. Say that once something like normal service resumes, revenue remains 10% lower than before – that’s plausible given some politicians already want planes to be kept to two-thirds of their former capacity – and EBITDAR, dented by airlines’ fixed costs, drops 15%.

One simple way to value American would be to put that profit on a multiple. Before the pandemic, American traded at 7 times EBITDAR. There isn’t likely to be any profit at all in 2020, so notch that down to 6 times for the lost year, and American’s all-in value would be $37 billion.

But American has $38 billion of net debt-like obligations, defined to include pension obligations and future plane lease payments. Assuming any new cash it draws or collects from the government gets spent staying alive, what’s left for shareholders is, in theory, worth less than zero.

Investors aren’t that pessimistic. They may think the airline will recover faster. But they also know that airlines don’t die easily. When American last went through bankruptcy and merged with US Airways, shareholders got 3.5% of the new company, while creditors got their money back in full. An important carrier, with the government already on board, could defy financial gravity.

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