An American Bankruptcy?

[nodoodahs]

I've been having some discussions about the airlines, specifically AMR and CAL, with Jack on the Stocks Or Bonds blog. Basically, we agree that their stocks may provide significant trading opportunities for people to make money, but we disagree about the long-term viability of the underlying companies. I think they're a bankruptcy waiting to happen. What follows is a discussion of AMR.

Is American Airlines a good trade?

As of November 10 2005, AMR had a short ratio of 9.5 with 28.6% of the float being short. It seems obvious that "good news" would be leveraged by covering shorts and therefore provide the volatility that a good trading stock needs. Speaking of volatility, there has not been a single month in the last two years when the high for AMR wasn't at least 13% above the low; indeed, in 17 of the last 24 months the high has been 25% above the low, and that includes going down from $17.65 to $6.34, up to $14.95, down to $10, and back to $19.14, with about 7 different whipsaws along the way. It seems likely that somebody made money trading this stock.

Was American Airlines a good company (pre-9/11)?

A lot of folks will point to the September 11 2001 incident as the downfall of the U.S.-based airlines. Keep in mind that, over the time period from YE 1996 to YE 2000, AMR managed to raise their revenues from $17.75 billion to $19.70 billion, a 11% increase, or 2.6% annualized. During the same time period, their EPS went from $6.08 to $4.81. This despite reducing the number of shares outstanding from 182 million to 152 million! Long-term debt increased from $4.5 billion in 1996 to $5.5 billion by YE 2000. During the same time, their current ratio went from 0.80 to 0.76 (neither of which is exactly encouraging). So what do we have, pre-9/11? A company with flat sales, declining margins, increasing debt, and dubious financial stability - in other words, a company that sucks.

What's happened to American Airlines since then?

On a revenue basis, AMR is essentially flat from 2000, about $20 billion in the most recent 12 months. Of course, this is way up from $17.3 billion in 2002, so that's something decent. At the same time, they've trimmed their losses to "only" $644 million in the last 12 months, from the average loss of $1.6 billion per year since 2000. However, long-term debt is now $13.2 billion, although the current ratio hasn't changed from the lousy and unstable 0.76. This is also the first year since then that AMR has actually made a net reduction in debt; each other year they have resorted to issuance of debt and stock to keep themselves solvent. I would give you a change in their debt to equity ratio, but they don't have any equity, sorry! It would take them 8.3 years of operating cash flow to pay off their current liabilities, and interest payments take up over 1/2 of their pre-interest operating cash flow. From YE 2001 they have gone from having positive $2.656 billion in tangible equity to having negative $1.931 billion in tangible equity, a net destruction of $4.587 billion dollars.

Can AMR recover?

It seems doubtful to me. Even a truly dramatic improvement in their operational cash flows would be hampered by the tremendous payments on debt, debt which has increased from an interest rate of 4% in 2001 to 6.4% in the most recent year.

Let's assume two (miraculous) things happen: first, a 10% increase in revenues, and second, a return to the EBITDA/Revenue margin last seen in 2000 (their last profitable year). Important note! This assumes their EBITDA/Revenue measure DOUBLES from 2005, or an extra $1.2 billion of EBITDA even without the assumption of increased revenues.

$22.1 billion in revenues multiplied by a 0.131 margin, minus $1.3 billion in dprcn and amort, gives you $1.6 billion in EBIT. Let's don't forget to add a generous $200 million for "other income, net" which is a bit more than average for the last 6 years. For the last 12 months, interest payments have been $842 million and they had a net repayment of debt of $42 million. To be conservative, we'll allow $950 million for PI in 2006 implying a significant $100 million reduction in long-term debt (at which rate they'll be long-term debt free in 132 years). That leaves $850 million in pretax income, reduced to $552 million after tax. Divide that by 161.2 million outstanding shares, and you have $3.42 per share. All in all, that would be a very remarkable recovery IMO.

What kind of valuation would that bring? The largest major airline, British Airways (BAB), carries a multiple of 15x earnings; no other airline has a multple over 8, the industry has no multiple, because it has no earnings. That 15x earnings multiple would put AMR at $51, and at an S&P 500 PEG of about 1.5, would imply annual EPS growth of 10% thereafter (unlikely IMO but I suppose theoretically possible). To make $55 per, they'd either have to exceed some fairly optimistic growth assumptions, or the industry would have to have significant multiples above the S&P 500 long-term average, which is unlikely for an industry like the airlines.

I still believe a bankruptcy is in their future, although how far into the future, is uncertain.
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I haven’t seen a beatin’ like that since somebody stuck a banana in my pants and turned a monkey loose.

[nodoodahs]

I saw this morning's news and immediately thought about resurrecting this old thread, but got busy at work. Glad to see somebody remembered ...

Ah, fundamentals, they are a long-term play. And it's STILL a lousy industry. Expect any debt relief here to be a continued negative factor on any other remaining high-debt airlines.
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I haven’t seen a beatin’ like that since somebody stuck a banana in my pants and turned a monkey loose.

[HenryTo]

Morningstar on the AMR bankruptcy.

[HenryTo]

I am certainly considering JBLU for a trade but probably will just leave AMR for the more adventurous. Note that the analyst fell asleep at the wheel, as short interest for AMR has declined from 9 days to only 5.5 days (the data was available when the article was published) - and absolute short interest is now probably near a post 9/11 low:

link
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Airlines Taxi For Take-Off
Bernie Schaeffer, Option Advisor 04.21.06, 6:00 AM ET

Cincinnati - Earlier this month, I ran across an article regarding hedge funds and airlines. It's the third such piece I've seen since June 2005.

The details of this latest piece have me wondering if these firms might be executing "paired" trades; that is, shorting some names--including JetBlue Airways (nasdaq: JBLU - news - people )--while assuming long positions in companies specifically mentioned in these articles, such as AMR (nyse: AMR - news - people ), Continental Airlines (nyse: CAL - news - people ), Delta Air Lines (nyse: DAL - news - people ) and Northwest Airlines (nasdaq: NWAC - news - people ).

AMR has had a nice flight. What should you do now, buy puts or calls on the airline stock? Click here for guidance from Bernie Schaeffer in Option Advisor.

I don't feel that analysts put enough credence into market capitalization to gain perspective on how "cheap" or "expensive" an industry might be. AMR, for example, has a market cap below $5 billion, which is why it's no sweat for a fund, even a relatively small fund, to acquire a 6% stake. Southwest Airlines (nyse: LUV - news - people ) has a market cap of $14 billion, which to me still screams "danger."

Short-interest figures on the airline names certainly don't support a "hedge funds are bullish on the airlines" argument, though this could hearken back to the new world of heavy short interest signifying heavy long positions. In other words, short positions may have been acquired as a hedge to a long position in the company's debt or a long position in another airline's equity.

Also note that there is no airline-based exchange-traded fund to attract this particular breed of investor. Given that there is no airline ETF and hedge funds often hedge long positions by shorting a related ETF, they may be forced to short other airline stocks, thus adding to the short-interest figures.

The sentiment waters are further muddied by ambivalent options data. Schaeffer's put/call open interest ratio (SOIR) readings are mixed across the board, leaving little clue of the prevailing opinion of the options crowd. Overall, however, short interest is near an annual high, suggesting that some of the smaller airline names are shouldering pessimistic sentiment from the equities crowd.

Technically speaking, the AMEX Airline Index (XAL) has put in a heretofore successful retest of intermediate-term support at its 160-day moving average.

For its part, JetBlue is currently intriguing as it has lost all analyst support and its market cap is down to $1.65 billion. There are some big May 12.50 calls overhead, but heavy January 2007 put open interest should keep the stock afloat.

One name that also looks intriguing, and enjoys a more promising Schaeffer's Equity Scorecard grade of 7.0., is AMR. The stock is trading near its 50% correction level of $23.70 (which is also the site of the stock's 20-week moving average). The shares have rebounded higher and are currently flirting with their 80-day moving average.

Short interest is rampant on AMR, comprising nearly 20% of its float and representing a short-interest ratio of nearly nine days to cover. Analysts are relatively supportive, but only seven brokerages cover this large airline, leaving open the hope of additional coverage on the horizon. Finally, puts are easily trumping calls in the April and May series, as evidenced by the stock's SOIR reading of 1.46.

From a fundamental perspective, AMR posted relatively strong earnings, announcing that it lost $92 million, or 49 cents per share, during the first quarter, compared to its year-ago loss of $162 million, or $1 per share. Sales for the three-month period spiked 13% to $5.34 billion.

The worrisome price of fuel is already largely factored into these stocks, so a positive uptrend combined with a healthy dose of pessimism equals a possible buying opportunity for me, no matter how beleaguered the sector.

[nodoodahs]

IMO every bankrupt carrier that keeps flying puts more pressure on the carriers with $13-plus billion of debt.

Jack thinks the fundies can improve enough for $4 EPS and $55 per on AMR. To mint $4 after tax, they need a $1.75 billion improvement from last year: $0.65 billion to breakeven, $0.1 billion to pay down some debt, and another $1 billion to get to $4 EPS after tax. Unlikely IMO.

AMR may make $55 per on speculation, however. I figure the recent action for a short squeeze, but it could still have legs.
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I haven’t seen a beatin’ like that since somebody stuck a banana in my pants and turned a monkey loose.

[HenryTo]

US Airways have been on a tear since its post-IPO bankruptcy.

http://finance.yahoo.com/q?s=lcc

I had thought about buying this for a short-term trade only right after the NWAC and DAL bankruptcies but did not pull the trigger, mainly because:

1) The airline industry still has poor fundamentals. 20 years ago, it would have been profitable to operate a low-cost and efficient airline. Today, that is no longer the case. It is amazing to see that so many investors are still throwing away money at these stocks and at restructuring NWAC and DAL, and so on.

2) This somewhat relates to the "throwing money at the airline industry" part. Richard Branson, the very successful British entreprenur, is also starting a U.S. low-cost airlines. That is, low-cost capacity on U.S. domestic routes is not going away anytime soon. The following picture (Branson with his fingers crossed) just says it all:

http://www.axcessnews.com/modules/wfsection/article.php?articleid=7090

3) The long-term bull market in oil and energy prices. Given the lack of oil hedges in play for most of the domestic carriers, I believe they will continue to bleed money on aircraft fuels.