Last Thursday, American Airlines (AAL 0.51%) confirmed that it returned to profitability in the second quarter. The airline also projected that it will earn another profit in the third quarter and said its plan to reduce total debt by $ 15 billion by 2025 is on track.
Nevertheless, American Airlines shares fell 10% over the following two trading days. This pullback isn’t a good buying opportunity, though. Between the company’s enormous debt load and its weak profitability, American Airlines stock still looks like a value trap.
Q2 results meet expectations
Earlier this month, American Airlines said that revenue increased about 12% compared to Q2 2019 last quarter, even though the carrier operated at 8.5% less capacity. The company also projected that non-fuel unit costs had increased 12% over the same period and fuel costs would average between $ 4.00 and $ 4.05 per gallon.
The final results came in roughly as expected. Revenue increased 12.2% over American’s Q2 2019 performance. Adjusted non-fuel unit costs rose 11.8%, while fuel costs came in at $ 4.03 per gallon.
American Airlines’ revenue growth was sufficient to return the company to profitability, but it couldn’t fully offset the effect of sky-high fuel prices. The airline giant posted an adjusted pre-tax margin of 5.1%, which was in line with its guidance but down from 9% three years earlier. Adjusted earnings per share totaled $ 0.76, down 58% compared to Q2 2019.
Margin pressure to continue
Looking ahead to the third quarter, American Airlines currently expects fuel prices to moderate slightly to between $ 3.73 and $ 3.78 per gallon. However, management anticipates that revenue growth (relative to 2019) will slow slightly to a range of 10% to 12%. Meanwhile, non-fuel cost inflation is accelerating. Adjusted non-fuel unit costs will likely rise 12% to 14% over Q3 2019.
On the bright side, American Airlines still expects to be profitable this quarter. That said, its projected 2% to 4% adjusted pre-tax margin hardly inspires confidence, given that the summer is typically one of the most profitable parts of the year for airlines.
Balance sheet woes continue
American Airlines ended the third quarter with $ 37 billion of debt, plus nearly $ 8 billion of lease liabilities. In the company’s earnings presentation, CFO Derek Kerr noted that total debt peaked a year ago and has declined by $ 5.2 billion since then. Alas, what management left out was that liquidity has declined by a similar amount. American Airlines has simply used excess cash to repay some of its debt.
American still had $ 12.5 billion of unrestricted cash and investments at the end of June, some of which will be available for additional debt repayments. That said, it needs to generate a meaningful amount of free cash flow to meet its 2025 debt reduction target.
Management says that low capital spending needs will enable the company to do just that. But while American Airlines is planning for capital expenditures of $ 2.7 billion in 2023 – fairly modest for an airline of its size – projected spending on aircraft and engines alone is set to rise from $ 1.9 billion next year to $ 3.2 billion in 2024 and $ 3.7 billion in 2025. Thus, capital spending will soon ramp up again, giving American a very brief window to generate the free cash flow it desperately needs.
A cheap stock that could keep getting cheaper
Based on the current analyst consensus, American Airlines stock trades for just eight times its projected 2023 earnings and four times its projected 2024 earnings. If the company achieves these targets, the stock could make big gains in the years ahead.
However, that’s a big if, particularly because the 2024 analyst consensus implies net income well above pre-pandemic levels. American Airlines faces numerous pitfalls, including rising labor costs, a potential recession-induced pullback in demand, and United Airlines‘strategic plan to dramatically increase its capacity over the next couple of years.
With over $ 22 billion of debt maturing between now and the end of 2026, American Airlines can’t afford any missteps. That’s a tough position for any airline to be in. Investors should continue to steer clear of American Airlines stock until the company gets a much better handle on its debt.