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American Airlines Group Inc. (NASDAQ:AAL) is the “largest airline in the world in terms of revenue passenger mile, scheduled passengers carried, and fleet size” according to ZIPPIA. Furthermore, the airline industry and travel industry are set to recover rapidly in 2021, as there is a global vaccination program to put an end to the novel coronavirus pandemic. So is AAL stock a recovery stock pick now?
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With better days ahead for air travel worldwide, investors may be asking themselves, “Why not grab shares of American Airlines now?” Not so fast. Don’t act without weighing the key risks. Currently, AAL stock faces too many challenges.
AAL Stock: The Big Picture First
What is the big picture when assessing whether any particular stock is attractive or not? In the financial analysis, the big picture is the broad economy. And very recently the Fed Chair Jerome Powell made some very important comments about the path of the economic recovery in the U.S. Two of those comments were that “the US economy is about to start growing ‘much more quickly,'” and that “the biggest risk to the economic recovery is another surge in coronavirus cases.”
The Fed Chair also mentioned that the U.S. economy is at an “inflection point,” and the economic recovery should continue based on a mix of fiscal and monetary policy and of course due to a massive vaccination program. But the key point to focus on is that he is worried about the event of a resurgence in coronavirus cases. And if we want to be pessimistic, the risk of coronavirus variants may require more than two shots to combat the pandemic completely. This means larger quantities of vaccines will be needed, and the vaccination program will require more time to be completed. Which is bad news for prospects of a full travel recovery and for airlines such as American Airlines.
But let us be optimistic. It is always a good idea to be on the positive side in life. What is next for AAL stock?
The Stock Chart Is Bullish, But Is It Enough?
The stock has a 52-week range of $8.25 to $26.09 per share, and it has witnessed strong gains of 79.5% on a one-year basis. Year-to-date, it is up about 40%. On MarketWatch, the average analyst rating for the stock is underperform, while on Yahoo! Finance the stock has a target price of $17.44 per share, or about 20% lower compared to the current price of $22.05.
Estimates are not too optimistic for the stock. So this brings me to my investment thesis and main argument. The fundamental analysis of the stock shows a very large risk, hard to ignore: massive debt.
Is American Airlines Too Big to Fail?
The fourth-quarter and full-year 2020 financial results were indicative of the very bad financial performance for American Airlines due to the coronavirus:
“Fourth-quarter revenue of $4.0 billion, down 64% year over year on a 53% year-over-year reduction in total available seat miles (ASMs).
Fourth-quarter net loss of $2.2 billion, or ($3.81) per share. Excluding net special items, the fourth-quarter net loss was $2.2 billion, or ($3.86) per share.
Full-year net loss of $8.9 billion, or ($18.36) per share. Excluding net special items, full-year net loss was $9.5 billion, or ($19.66) per share.
Ended the fourth quarter with approximately $14.3 billion of total available liquidity. The company expects to end the first quarter of 2021 with approximately $15.0 billion in total available liquidity.”
The decline of 62% for revenue of $17.34 billion for 2020 compared to revenue of $45.77 billion in 2019 is no surprise.
What worries me is the level of debt the company now has. In 2018, there was a significant long-term debt increase to $29.08 billion compared to $22.51 billion in 2017, or an increase of 29%. In 2020, the long-term debt increased further to $36.57 billion.
Now, the first place to look at whether the company can pay off its debt should be free cash flow and its trend. And doing so unveils a huge problem for American Airlines.
The last time the company had a positive free cash flow was in 2016, when it reported $793 million. In 2017, the free cash flow turned negative to $1.23 billion, and in 2020, the free cash flow reported was a negative number of $8.5 billion. To make things worse, the stock has an Altman Z-Score of -0.4, according to Gurufocus, which implies bankruptcy possibility in the next two years.
With a cash-to-debt ratio of only 0.17 and a debt-to-equity ratio of -5.97, American Airlines has very weak financials. If you check the total shareholders’ equity, its trend there is deterioration as of 2017, and for 2020 it was reported at negative $6.87 billion. This means that if the company was to be liquidated, the value of the assets is not enough to cover all liabilities. A very scary scenario.
Another reason for concern is that the company can no longer repurchase its stock or pay shareholders a dividend. Why? It is the result of taking coronavirus relief loans from the U.S. government. And this reduces more of the attractiveness of the stock.
The Good News
The airline stocks are expected to benefit from the increase of demand for traveling by air as a result of the coronavirus vaccination effort in the United States as well as globally. The updated CDC guidelines now allow fully vaccinated Americans to travel to and from domestic destinations without quarantine. And without the need for a Covid-19 test. So things should improve quickly for American Airlines — and other airlines too.
Management has realized that liquidity is essential and has taken steps to improve its liquidity position. It is absolutely vital and very critical now. And the airline is focusing now on repaying a loan issued by the U.S. Treasury last year. These are all pieces of positive news.
AAL Stock: The Verdict
As of 2016, the company has deteriorated its net margin, which turned to a massive negative 51.25% for 2020. American Airlines has huge debt, negative free cash flows and critical liquidity issues. Its stock now is overvalued and too risky. The company needs to take important steps and make important decisions. Things will not be easy, not just for 2021 but for the next few years. The logical and fundamental analysis suggests the best move is to avoid the stock now.
On the date of publication, Stavros Georgiadis, CFA, did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Stavros Georgiadis is a CFA charter holder, an Equity Research Analyst, and an Economist. He focuses on U.S. stocks and has his own stock market blog at thestockmarketontheinternet.com/. He has written in the past various articles for other publications and can be reached on Twitter and on LinkedIn.