The COVID-19 pandemic has taken a heavy toll on the U.S. airline industry over the past year. Fortunately, most U.S. airlines entered 2020 with strong balance sheets, thanks to the industry’s strong profitability over the previous decade.
Among major airlines, American Airlines (NASDAQ: AAL) was an exception to this rule. The airline giant has wasted billions of dollars on share buybacks in recent years, even as it spends heavily to modernize its fleet. This puts him in a weak position compared to peers like Delta Airlines (NYSE: DAL). However, American just bought some time by lining up $ 10 billion in new funding.
Dealing with a possible liquidity squeeze
Like its peers, American Airlines borrowed a lot of money in 2020 to cover its cash consumption. At the end of the year, it had $ 32.6 billion in debt and finance leases on its balance sheet, up from $ 24.3 billion a year earlier.
American entered 2021 with $ 6.9 billion in cash and unrestricted investment, plus $ 7.4 billion in additional borrowing capacity (mostly from a government loan commitment). Having $ 14.3 billion in cash may sound like a lot. However, American is still burning a lot of money. He expects average daily cash consumption of $ 30 million in the first quarter, or the equivalent of $ 2.7 billion in the quarter.
Of course, cash consumption should improve rapidly over the next few quarters with the return of demand for air transport. That said, the company has $ 21.7 billion in debt maturing between 2021 and 2025. It will not generate enough free cash flow to pay off all of those maturities. And while American Airlines should be able to refinance much of this debt, it might not be able to do so on favorable terms, especially for debt that is unsecured or backed by below-average collateral. .
Compare that with Delta’s financial situation. Delta Air Lines ended 2020 with $ 14.1 billion in cash and unrestricted investment on its balance sheet. It also had $ 2.6 billion in borrowing capacity on its revolving lines of credit. Additionally, Delta has spent less cash than American and only has $ 15.7 billion in debt maturing over the next five years.
Take advantage of the loyalty program
To meet its short-term cash flow needs, American Airlines decided to follow its biggest rivals by creating its loyalty program as a new subsidiary and using it as collateral. The timeliness of this guarantee allowed it to obtain a score just two notches below the investment grade status of Moody’s. It was an impressive achievement, given the carrier’s weak balance sheet.
American Airlines finally raised an industry record $ 10 billion, supported by the AAdvantage program, compared to his initial plan to raise $ 7.5 billion. The weighted average interest rate stood at 5.575%, slightly higher than the blended rate of 4.75% achieved by Delta when it issued $ 9 billion in debt backed by its loyalty program last September.
The $ 10 billion deal increases American’s liquidity by $ 2.5 billion, net of the termination of its participation in the federal guaranteed loan. This gives the business more leeway to cover its short-term cash consumption and debt maturities, reducing the likelihood of a cash flow crunch.
Fundamental problems remain
The new financial package saves American Airlines time. (It also allows the airline to avoid the adverse terms associated with federal loans available under the CARES Act.) However, that doesn’t mean the company is out of the woods.
First, American Airlines recorded mediocre adjusted pretax margins of 6.3% in 2018 and 2019. Margins could be even worse going forward. First, net interest expense will be around $ 2 billion per year after the debt is issued this week, up from $ 1 billion in 2019. That alone would reduce future pre-tax margins by more than 2 percentage points. percentage. Falling demand for business travel and a more challenging competitive environment could also weigh on profitability for the foreseeable future, offsetting the benefit of cost reductions.
Second, American had over $ 40 billion in net debt (including pension and lease liabilities) at the end of 2020, far too much relative to its earning power. Its new debt package reduces the risk of short-term liquidity problems, but does not solve the underlying problem of excessive leverage.
Certainly, putting in place additional long-term funding is an important step in American Airlines’ efforts to recover from the COVID-19 pandemic. However, with American’s market capitalization having already surpassed its pre-pandemic level, this may be a good opportunity for shareholders to head for exits.
This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are heterogeneous! Challenging an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.