Capex Reductions Could Help American Airlines Stave Off Bankruptcy

American Airlines (NYSE:AMR) has taken another stride towards reducing capital expenditures with the inking of a sale-leaseback deal for 15 Boeing 737-800NGs. ^[1] The aircraft had previously been ordered direct from the manufacturer, but will now be purchased by International Lease Finance Corporation (ILFC) before being leased back to American Airlines. By opting to lease rather than purchase the planes, the carrier frees up cash flow and reduces its capital expenditures – a strategy that the company hopes will allow it to keep up with competitors such as Delta (NYSE:DAL).

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Fuel Bill Necessitated Massive Fleet Renewal

With an average aircraft age of 15 years, American Airlines has been wedged between a rock and a hard place since oil prices started rising after the recession. Jet fuel expenses presently account for 43% of domestic revenue, heaping pressure on the airline to retire its gas-guzzling fleet and take to the skies with more fuel-efficient planes. By way of comparison, domestic fuel costs at competitor US Airways (NYSE:LCC) are equivalent to just 33% of revenue.

American Airlines hit back in July by announcing details of the largest commercial aircraft order in history, committing to buy 460 narrowbody jets from Boeing and Airbus with options for hundreds more. ^[2] But with net debt of $24 billion, equivalent to $70 per share, the airline can ill afford to pay for the aircraft outright. As with the 15 planes separately being loaned from ILFC, it has therefore demonstrated a clear preference for operating leases.

Leases Ground CapEx Even as New Jets Take Off

Capital expenditures as a percentage of EBITDA came in at 59% last year, marking a dramatic reduction from the previous two years. We believe the ongoing focus on operating leases will see CapEx continue to fall, hitting 38.6% in 2013 before leveling off at around 23.6% in 2015. Try dragging the trend-line below to see how this gradual decline impacts our $6 stock price estimate.

By leasing aircraft, American Airlines acquires cost-cutting assets for a fraction of the initial outlay associated with direct purchases. What’s more, the short lifespan of commercial aircraft means that once leases expire, any purchase options will reflect a significant markdown on original list prices. Both today and in the future, falling CapEx spells good news for this stock. It should be noted that while these operating leases will result in lower CapEx, we capitalize operating leases in our models so they will be reflected in our net debt calculation.

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1. ILFC SECURES SALE-LEASEBACK DEAL WITH AMERICAN AIRLINES, ILFC, Nov 9 2011 [↩]
2. American Airlines to Order 460 Narrowbody Jets to Replace and Transform its Fleet, AA, July 20 2011 [↩]