The airlines are high-risk stocks here with passenger traffic down over 95% and American Airlines (AAL) is one of the riskiest in the sector. The ability of the airline sector to obtain government aid to cover payroll costs is a huge positive for the sector. The move eliminates the direst outcomes for the sector making American Airlines a risky way to play a rebound in air travel demand.
Big Government Grant
On April 14, the airline sector and the U.S. Treasury Department agreed to a deal on the Payroll Support Program part of the CARES act providing $25 billion worth of aid to the passenger air transport sector. With the largest employee base, American Airlines obtained the largest deal at $5.8 billion. The airline had pre-virus monthly payroll expenses of $1.2 billion.
As shareholders, the deal was disappointing in that 30% of the “grant” was via a $1.7 billion low-interest loan. Only $4.1 billion of the grant is free money, if the airline doesn’t lay off employees prior to October 1 along with agreeing to restrictions on executive compensation and the elimination of capital returns.
The deal wasn’t the best outcome for shareholders, but the move eliminates the dire outcomes. The airline is now able to remain ready for an eventual rebound in air travel with only a 3% hit to equity via the warrants issued to the Treasury.
Besides, Delta Air Lines (DAL) announced over 35,000 employees out of a base of 90,000 employees have already accepted unpaid leave options. The airlines have the potential to reduce costs closer to the levels of the grants making the loan portion of the grant usable for covering operating losses.
Deep Value Sprinkled With Risk
Last year, American Airlines generated over $3.7 billion of operating profits while taking a large hit from having to ground 737 Max planes. The stock has a market value down to only $4.7 billion leaving a major question of when or if the airline can ever return to previous profit levels.
The Treasury grant gives the sector about six months to recover before having to make any drastic changes to the business model or cut employees. The reduced jet fuel costs will help in a recovery as those prices should remain far below prior virus levels for years with reduced energy demand.
If American Airlines can just return to half of the previous operating profit levels, the stock trades at only 2x profit targets. Of course, the risk is that travel never returns to previous levels.
The airline is asking for another $4.75 billion in loans from the government at a cost of another 38 million warrants. If granted, the U.S. Treasury will own over 10% of the airline, but American Airlines will survive to fly another day and allowed to profit when passenger traffic returns to pre-virus levels.
The key investor takeaway is that American Airlines remains in a risky position until bookings start rebounding to levels above 50% of previous capacity levels. Anybody thinking passenger traffic returns to 75% of 2019 levels should load up on all airlines, especially American Airlines with the stock down over 60% from the February highs.
When looking at Wall Street’s stance, AAL’s current average price target implies double-digit upside, but based on all the ratings received over the past three months, AAL is actually a Moderate Sell consensus. While 3 analysts are on the Buy side, 5 say Hold and 7 advise investors to jump out of the airplane. The latter camp includes J.P. Morgan’s Garrett Nelson, who recently downgraded the stock from Buy to Sell, while withdrawing his price target. (See American Airlines stock analysis on TipRanks)
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