Never has a stock had so many bankruptcy questions while trading near $10 per share. Yet, American Airlines Group (AAL) finds the stock in just that situation. At the depths of the virus panic and when financial aid was questionable, some bankruptcy fears were logical. But now, the more logical outcome is a return to a very profitable airline on the verge of substantial free cash flow generation. My previous research that America Airlines has plenty of breathing room is only reinforced by the resurgent passenger demand heading into the Memorial Day weekend.
On May 12, only 163K passengers went through the TSA checkpoint. On May 22, nearly 350K passengers flew on U.S. airlines. In the course of 10 days, the U.S. capacity grew from 7.5% to 12.5% of 2019 levels. The sudden launch in traffic dramatically alters the view of whether airlines end up filing bankruptcy.
When looking at the rebound in a closer view of the drop, the passenger counts are making a U-shape rebound. Again, these aren't the types of traffic rebounds suggestive of bankruptcies in the airline sector.
In the next few weeks, both Las Vegas and Florida theme parks in Orlando will reopen. The flying public will now have substantially more reasons to actually fly, breaking the mindset that people weren't flying due to fears when the issue is the lack of destinations without travel restrictions. For now, Hawaii still has a 14-day quarantine requirement until at least June 30 for people flying to the islands which naturally restricts any tourists.
China air traffic is already above 40% of pre-virus levels. Even Delta Air Lines (DAL) recently targeted a return to 50% of previous traffic levels by the end of September. The market initially ran blindly negative with the airline planning to furlough half of its pilots, but the news was actually a positive indication Delta plans to maintain the other half of its pilots due to a forecasted resurgence in demand.
Path To Breakeven
As highlighted in numerous of my articles about the airlines, the path to cash flow breakeven isn't as far away as the market thinks. The sector isn't correctly factoring in the PSP grant from the U.S. Treasury, causing an irrational view of daily cash flow burn rates. Not to mention, some of the initial cash burn numbers, including those from American Airlines, were highly inflated by refunds in the short term.
My last article provided some key figures for investors to absorb. The airline predicted ending June with a daily cash burn rate of $50 million. The number factors in booking finally catching refunds and didn't factor in the daily PSP grant of $22.5 million to cover some payroll costs. American Airlines obtained a $4.1 billion grant to cover the 183 days from April 1 to September 30.
The actual daily cash burn from operations was only forecasted in the $27.5 million range. The $50.0 million is more of a liquidity burn rate with the PSP included in the liquidity amount. The airline will eliminate those related payroll costs after September 30 assuming traffic hasn't returned to normal levels.
This amount most notably included no benefit from an improving revenue trend. Crucially, America Airlines provided this forecast back on April 30 along with the Q1 earnings call where CEO Doug Parker made the following statement regarding the revenue portion of the daily cash burn:
As a result of all that, we expect to end this quarter with approximately $11 billion of liquidity and a significant amount of unencumbered assets still in place. That forecast assumes little to no increase in demand for air travel throughout the quarter.
At the time, daily domestic passengers were only back to 120K or barely 5% of 2019 capacity levels. With reduced fares, the 5% capacity along with loyalty fees and cargo revenues likely generated between 5% and 10% of 2019 revenues.
Since April 29, traffic has already been documented as reaching 12.5% of 2019 levels. In essence, traffic levels are up 150% since American Airlines provided the daily cash burn levels which included limited expectations for increased demand.
A return to 30% of 2019 traffic levels when combined with loyalty fees and cargo revenues, American Airlines should reach at least 30% of Q2'19 revenues of $12 billion. In such a case, the airline would generate ~$40 million in revenues per day ($3.6 billion for the quarter) or somewhere around $27 million per day above the revenues from when the airline reported numbers at the end of April.
The only big question is variable costs from increasing capacity from 20% of 2019 levels to 30%. What we do know is that revenues are large enough to wipe out the cash burn and variable costs such as payroll aren't increasing because the PSP required the airlines to keep those costs elevated.
The big variable is fuel which cost the airline $2.5 billion last Q2. Additional costs such as maintenance, landing fees and selling expenses were another $1.5 billion. The $2.6 billion in other expenses are generally variable as well.
The big key here is that fuel costs are down 50% so a normalized view of those expenses are $1.25 billion. Combined with these other variable expenses, American Airlines has $5.3 billion of quarterly expenses that dip to $1.06 billion with capacity at 20% and $1.59 billion up at 30%. The $530 million in additional costs is only $5.9 million per day in June.
Revenue growth eliminates all but these additional costs from the daily cash burn rate. With these low fuel costs, capacity at 40% would actually lead to positive cash flows. The big wild card is that at 50% capacity and with jet fuel over 50% below last year's costs per gallon, American Airlines saves over $2 billion on fuel coast per quarter.
In the end, American Airlines gets really close to cash flow breakeven around 30% of previous capacity levels as long as jet fuel costs remain below half of 2019 prices above $2/gallon. The real key to investors is that the airline reduces cash burn dramatically at these capacity levels and a shareholder can sit back and relax that bankruptcy fears will completely disappear. With bankruptcy off the table, shareholders can fully participate in the eventual rebound to record travel demand that always occurs after previous virus and terrorist fears pass.
Takeaway
The key investor takeaway is that American Airlines gets rather close to operating cash flow breakeven at 30% capacity. With bookings up, the airline might actually turn the daily cash rate to positive levels by the end of June. In addition, higher capacity rates will help cut the losses by July and August.
Even without considering far better cash flow metrics due to surging travel demand, American Airlines forecasted ending June with $11 billion in liquidity. The stock has very low risk of bankruptcy here with the only possible negative outcome coming from another virus related travel shutdown. The stock is a buy here below $10.
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