American Airlines‘ (NASDAQ: AAL) the recovery from the COVID-19 pandemic accelerated in the last quarter, according to a recent update from the company’s investors. This is good news for the struggling airline giant.
However, as business improves faster than expected, American continues to lag its competitors as Delta Airlines (NYSE: DAL) in terms of profitability. Combined with the company’s weak balance sheet, this will keep American Airlines shares on the ground for the foreseeable future.
A solid increase in guidance
In early June, American Airlines told investors that booking dynamics and load factors (the percentage of seats occupied by paying customers) had increased as summer approached. At that time, the company reaffirmed its initial forecast of a 40% drop in revenue compared to the second quarter of 2019 with 20-25% less capacity.
American raised its outlook on Tuesday. Management now estimates that revenue fell 37.5% from the second quarter of 2019 – better than previous forecasts – on a capacity reduction of 24.6%. In addition, the carrier’s cost control measures have been more effective than expected. As a result, the airline expects to report an 11-12% increase in adjusted unit costs excluding fuel from the second quarter of 2019, better than its previous forecast of a 13-17% increase.
This improvement in its forecast could allow American Airlines to post a slight profit before tax according to generally accepted accounting principles (GAAP) in the second quarter. However, that includes a benefit of about $ 1.4 billion from government payroll support grants. Excluding these subsidies, the airline expects to lose at least $ 1.4 billion pre-tax, placing its adjusted pre-tax margin between -19% and -20%.
Better doesn’t mean good
American’s expected second quarter performance compares unfavorably with the results reported by Delta Air Lines this week. Delta reported significant GAAP pre-tax income of $ 776 million last quarter. After canceling payroll support subsidies and other special items, it recorded an adjusted pre-tax loss of $ 881 million. This translates into an adjusted pre-tax margin of -13.9%.
If we consider only the core business of Delta Air Lines, the underlying performance gap between the two carriers was even larger. Delta’s oil refinery posted an operating loss of $ 157 million last quarter due to the high price of renewable fuel credits, adding significantly to the company’s overall loss.
American Airlines’ current margin deficit compared to key competitors like Delta does not bode well for future profitability. In the long run, strong competition will limit profit margins at the industry level. So if American’s pre-tax margin continues to lag more than five percentage points behind its top-performing competitors, the full-service airline could end up with single-digit margins.
American Airlines ended the first quarter with colossal $ 48 billion in debt and lease debt, as well as a $ 6.8 billion pension deficit, compared to just $ 14 billion in cash and non-investment. affected. This is by far the biggest indebtedness in the industry.
While American’s net debt declined in the last quarter, that included $ 2.6 billion in cash payroll support grants. Additionally, the second quarter tends to be seasonally strong for airline cash flow. Without these favorable winds, net debt could rise again in the second half of 2021.
Despite the company’s weak cash flow, below-average earnings outlook, and massive leverage, American Airlines’ market capitalization is higher than it was in early 2020 (i.e. before the pandemic). To put it bluntly, it doesn’t make sense. It’s an airline title long-term investors should avoid.
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! Challenging 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.