AAL Stock is Too High

Airline stocks have seen a significant uptick over recent weeks thanks to a surge in passenger throughput at TSA checkpoints. Interestingly, American Airlines stock (NASDAQ: AAL) has been the top performer in this rally as it has gained 60% since June 1 (with the gains almost touching 100% early last week) compared to the 20% growth in Jets ETF. While the easing of lockdown restrictions across various states have boosted investor sentiments, Trefis believes that American Airlines stock is considerably overvalued at the current level of $18, primarily due to its ever-increasing long-term obligations despite ongoing efforts to reduce the daily cash burn rate. As the growing interest expenses are expected to weigh on margins until debt retirements, we have maintained our price estimate for American Airlines’ stock at $8.

Revenue growth expectations remain low and profitability to be hurt from growing interest expenses

In 2019, American Airlines generated $45.7 billion of total revenues and incurred $42 billion in operating expenses – achieving an operating margin of 8%. The company also incurred $1 billion in interest expenses, which brought the net income margin down to 5%. Growing interest expenses from expanding long-term debt have been the key factor resulting in a staggering 65% drop in AAL’s stock since the beginning of 2018.

Recently, the company’s management announced a reduction in the cash burn rate from the earlier targeted level of $50 million per day. Even at a $40 million of a daily cash burn rate, we expect the company to avail the $4.75 billion of CARES Act loan to improve its cash position if the demand does not recover this year. The incremental interest expenditure associated with the loan will further delay shareholder returns until there is an improvement in operating margin or a sizable chunk of debt is retired. Thus, the company’s net margins are expected to deteriorate further from the $200 million of additional interest expenditure. Assuming air travel demand will recover completely by 2021, it will take the company nearly eight years to completely repay its $30 billion in long-term debt obligations using the current operating margin and minimal levels of capital expenditure.

International travel to remain subdued despite the easing of restriction measures

Per recent filings, the company has planned to increase its domestic and international capacity to 55% and 20% in July, respectively. However, we expect the passenger occupancy rate to remain low on international routes due to stringent quarantine measures for international travelers as well as extremely low demand for international travel. As revenues from international routes contribute 30% of the company’s top line, the tepid demand is expected to further deteriorate margins in the near-term. Considering the negative impact of ballooning debt on stockholder returns and a 40% decline in revenues, we estimate American Airlines Valuation at $8 per share using a P/S multiple of 0.1, $28 billion in revenues, and 426 million in shares outstanding.

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