American Airlines Will Continue to Underperform Under the Weight of Its Debt

• American Airlines (AAL) is positioned for gradual recovery in utilization and cash flows
• Total debt of $38.1 billion is likely to remain a key concern as the credit stress impacts equity holders
• Prospects of further dilution also make the stock unattractive, so investors should look elsewhere for airline stocks

The black swan even of the Covid-19 pandemic triggered one of the worst phases the travel and tourism industry has ever seen. Airline companies survived the pandemic with bailout support from the government. While the worst of it seems to be over, investors need to be very selective when choosing stocks from the industry. American Airlines (NASDAQ:AAL) does not seem to be one of the best investment options.

However, this does not imply the company has no positive fundamental news. American Airlines ended 2021 with a robust liquidity buffer. Operating cash flows also turned marginally positive after considerable cash burn in 2020.

The airline has also initiated significant cost cutting, which is likely to yield results in the long-term. It’s also worth noting the company has a younger fleet than Delta Air Lines (NYSE:DAL) and United Airlines (NASDAQ:UAL).

Even with these positives, AAL stock has remained depressed. Let’s discuss the concerns that dominate sentiments about the stock.

Travel Recovery Remains a Key Concern

In terms of price action, AAL stock has witnessed selling pressure after every rally. There have been trading opportunities in the last 12 months. However, AAL stock is down by 24% during this period.

There are two primary reasons for the stock remaining sluggish. One is directly linked to Covid, and the other is on its balance sheet.

First and foremost, data from the International Air Transport Association shows that overall traveler numbers in 2021 were 47% of 2019 levels. This should increase to 83% in 2022 and 94% in 2023.

It’s only in 2024 that traveler numbers will exceed pre-pandemic levels. Therefore, the recovery is likely to be gradual. Additionally, recovery in the industry faces headwinds from new Covid-19 variants.

Credit Stress Will Impact AAL Stock

Furthermore, American Airlines survived the pandemic by significant leveraging. As of December 2021, the company reported total debt of $38.1 billion. For 2021, it saw $1.8 billion in interest outflow. A deeply burdened balance sheet puts more focus on deleveraging than any benefits for equity holders in the foreseeable future.

I must add that for 2021, American Airlines reported operating cash flow of $704 million. With another headwind in the form of higher fuel prices, it’s unlikely operating cash flows will be robust in 2022.

American Airlines ended Q4 2021 with a robust liquidity buffer of $15.8 billion. However, sluggish cash flows and investments will ensure the balance sheet remains stressed. Even if I had to consider exposure to the airline industry, I would look at companies that have low credit stress.

For example, JetBlue Airways (NASDAQ:JBLU) and Southwest Airlines (NYSE:LUV) look better from a credit perspective. With a meaningful industry recovery, I expect these airlines to outperform AAL stock.

AAL Stock Has a Long Road to Recovery

There is pent-up demand for travel, and airline capacity utilization is likely to increase in the coming quarters. Even with the fuel cost headwind, operating cash flows are likely to remain in positive territory.

However, American Airlines will continue to be burdened by the significant cost of its debt in the next few years. With interest rates on an uptrend, debt refinancing might also imply that cost of debt will increase further.

It’s also worth adding here that as of December 2021, the airline reported flight equipment of $37.9 billion. With total debt of $38.1 billion, the loan-to-value ratio is more than 100%. Given the credit stress, I don’t expect AAL stock to deliver returns that beat the index even if it trends higher from current levels.

Recently, Wolfe Research also indicated American Airlines might need to dilute equity to cover its cash burn as oil trades above $100 per barrel. Potential dilution is another factor that will continue to impact the sentiment surrounding AAL stock. For now, investors should consider other stocks in the industry.

On the date of publication, Faisal Humayun did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.