American Airlines: Struggling Without the Death Rattle

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                                                                                                                       Photo by Miguel Ángel Sanz on Unsplash

The airline industry has been struggling in a world of COVID-19. With a drastic decrease in air travel, many planes are now sitting on runaways. Having nearly $0 of revenue during this time but having to deal with operating expenses, it's a matter of time before the airlines run of cash and need to shut down. 

A few weeks ago, Boeing's CEO David Calhoun said that he sees a major US airline going bankrupt by the end of this year. This has sparked a lot of pessimism in the airline industry. To predict which airline will go bust, many people looked at the credit-default swaps of the different airlines. Because American Airlines had its CDS trading at higher levels compared to its peers, many believed that American Airlines would go bankrupt. 

A deeper dive on American Airlines

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Bear Case

One reason why many investors would be worried about the airliner is that it has struggled to achieve free cash flow for years. When looking at Yahoo Finance, they were free cash flow positive in 2016 but became free cash flow negative after that. 

In their recent quarter, the company was burning between $50 million to $70 million a day. Note that in the meantime, the company has $11 billion in liquidity and $34 billion in debt. This situation makes it tougher for American Airlines to survive during a time of $0 revenue for months. 

Also, during normal times, American Airlines exhibited the lowest profit margins among the large carriers. With net margins of 1.7%, the amount of money the airline makes isn't a lot. It's very little. 

During this pandemic, the company got $5.8 billion in grants and loans to withstand the economic pressures of the pandemic. They even used their AAdvantage program as collateral on their debts. That program is worth $4.75 billion. 

American Airlines is taking many steps to ensure its survival during this pandemic. 

Despite all that, American Airlines's 5-year credit default swap trades at 6000 bps. To give you perspective, Lehman Brothers had its credit default swaps were trading at 7000 bps the night before it declared bankruptcy. From that perspective, many investors are betting that the end for American Airlines is near. 

Debunking the Bear Case

The huge debt is a big concern for investors. Since bankruptcy helps companies deal with their debts, many believe that the airliner would declare bankruptcy in order to relieve its debts. 

Interestingly, $12 billion of American Airline's debt is secured. The rest of it isn't. In the next 24 months, the airline won't be dealing with large non-aircraft debts maturing. This helps the company's liquidity position as they won't have to pay a lump sum of cash on its debts soon. 

Since the company had $34 billion in debt with $12 billion of its debt being secured, the company has $22 billion of debt that can be negotiated with creditors. They can have the creditors take their older planes as a way to repay their debts is one possible option. 

The liquidity situation for American Airlines is more manageable than many think. If American Airlines is successful with its negotiations with its creditors, then the airline can live to fly another day. 

Other things to note

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Many business experts will say that the airline industry has been built on bankruptcies. Around the early 2000s when the industry was consolidating, many airlines were about to go bankrupt. The mergers that happened throughout that time period is what led to the creation of the major airlines today. 

Also, the biggest problem with airlines today is revenue. Their debt situations can be managed through bankruptcy and negations. If some do choose to go on the path of bankruptcy, then the airlines can come out of the bankruptcy proceedings as smaller, leaner, and more profitable.