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Thusday, American Airlines (NASDAQ: AAL) reported a slightly lower quarterly loss than analysts had expected. But make no mistake: American’s third quarter results were by far the worst of any major US airline. The carrier also expects to lose more money than any of its competitors in the fourth quarter. The lesson for investors is clear: Avoid this struggling company.
Another bad quarter
Three months ago, many airlines expected to be profitable in the third quarter, thanks to a strong rebound in summer leisure travel. However, despite the improving demand environment, American Airlines never expected to make a profit in the third quarter, mainly due to its high cost structure and crippling interest charges. Management’s initial forecast was for American to achieve an adjusted pre-tax margin of -3% to -7%, with revenue down 20% from the third quarter of 2019.
Adding to the airline’s woes, demand stagnated around the beginning of August as the number of COVID-19 cases in the United States increased. In early September, American Airlines cut its quarterly forecast, saying it expected revenue to decline 24% to 28% from Q3 2019, leading to an adjusted pre-tax margin of between -10% and – 14%.
Ultimately, American third-quarter revenue totaled $ 9 billion, down 25% from two years ago. The company posted an adjusted pretax loss of $ 833 million, bringing its adjusted pretax margin to -9.3%: better than its most recent forecast but still much worse than its initial quarterly forecast. (American made a profit of $ 169 million under generally accepted accounting principles, but that included a substantial benefit from the latest batch of federal payroll support grants.)
Image source: American Airlines.
To put the American results in context, its main rival Delta Airlines (NYSE: DAL) reported modest adjusted earnings for the third quarter earlier this month. During this time, United Airlines (NASDAQ: UAL) posted a lower adjusted pretax loss of $ 473 million, resulting in an adjusted pretax margin of -6.1%.
The fourth trimester will be worse
American Airlines’ financial results will likely deteriorate further in the fourth quarter, which tends to be a weaker seasonal time for airlines. On Thursday, the company said it expects a 20% drop in revenue from the fourth quarter of 2019, with 11-13% less capacity. Adding to the pressure on profits, non-fuel unit costs are expected to increase by 8% to 10% during this period and fuel prices could climb about 20% from the $ 2.05 per gallon paid by Americans two years ago.
Based on these projections, management expects American Airlines to post an adjusted pre-tax margin of -16% to -18% this quarter. This implies a pre-tax loss of about $ 1.5 billion.
Unless American surpasses these targets by one mile per country, its fourth quarter financial results will once again be lower than Delta and United. United Airlines’ forecast implies an adjusted pre-tax loss of around $ 1 billion this quarter, and Delta Air Lines will in turn post a much smaller loss than United.
Huge risk and few benefits
Analysts currently expect most US airlines to make substantial profits next year (assuming there are no further setbacks from the pandemic). In contrast, analyst consensus currently calls for American Airlines to make negligible profit in 2022.
Image source: American Airlines.
American Airlines’ weak balance sheet makes its still low profitability particularly dangerous. American ended the last quarter with $ 38.3 billion in debt, plus about $ 15 billion in retirement and lease debt. In addition, the airline used more than $ 1.7 billion in cash in its operations in the last quarter. Based on its weak earnings forecast for the fourth quarter, it will likely burn even more cash this quarter.
To be fair, American ended last quarter with $ 14.5 billion in unearmarked cash and investment, giving it time to turn things around. However, the company has nearly $ 20 billion in debt maturing by the end of 2025. If American Airlines still doesn’t generate significant profits and cash flow within a few years, it could struggle. to pay off or refinance all that debt.
This creates substantial risk for investors. On the flip side, American Airlines’ fully diluted market capitalization has rebounded beyond its January 2020 (i.e. pre-pandemic) level. Thus, investors do not get a discount for assuming this risk, which makes American Airlines shares extremely unattractive.
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! Questioning 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.
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