American Airlines

Moat: 1/5

Understandability: 2/5

Balance Sheet Health: 1/5

American Airlines is a major global airline providing passenger and cargo transportation services. However, this highly competitive industry faces structural and economic challenges that impede profitability.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

American Airlines, like most legacy carriers, operates in a brutally competitive industry with high fixed costs and cyclical demand. Its lack of a moat stems from the commoditized nature of airline services and constant competition.

Business Overview

  • Revenue Distribution: American Airlines generates revenue primarily through passenger travel (87.9%), cargo (10.2%), and other services (1.8%) as of the nine-month period ended September 30, 2023. Notably, passenger travel is driven by the number of passengers and the prices of tickets.
  • Trends in the Industry: The airline industry is intensely competitive with low barriers to entry, except those that depend on economies of scale, creating price pressure. External factors such as fuel costs, economic conditions, and political issues influence the airline industry heavily. Also, the airline industry is cyclical, with the demand for travel being quite sensitive to macroeconomic conditions. The industry has shifted to a hub-and-spoke model, creating consolidation around hubs as it’s the most profitable way to operate. Low-cost airlines can achieve better load factors, higher turnover rate of planes, and more passengers per employee, and have a lower cost structure, which makes them a very formidable competitors.
  • Margins: The airline industry is notorious for having thin operating margins due to competition, cost pressures (especially fuel), and other operational and fixed costs.
  • Competitive Landscape: The industry is highly competitive, characterized by intense price competition and constant pressure to reduce costs. Airlines frequently compete with each other in their routes and are subject to new entrants and consolidation. American Airlines is one of the four major airline companies in the USA, along with Delta, United and Southwest. But they also compete with other airlines such as JetBlue, Alaska, Spirit and Frontier, and there are also several regional airlines that compete with American as well. Also, there are a growing number of international carriers that can make inroads in this industry.
  • What Makes the Company Different: American Airlines is differentiated via its global network, with hubs in major cities across the USA. The company also participates in the Oneworld Alliance, a global airline alliance. The company has an extensive loyalty program and a large fleet of aircraft. However, many of these characteristics are easily replicated by their competitors and therefore, not a sustainable advantage.
  • Other Relevant Things: AAL has a very significant amount of intangible assets on its balance sheet ($11.6 B), much more than their equity ($2.9 B), which is not a good sign. They have also made several acquisitions, such as AAG, which has not benefited them significantly. They also make money from credit card agreements.

Financials Overview

  • Recent Results: American Airlines reported a Net Loss of ($208) million in its Q3 of 2023. It reported revenues of $13.5 Billion in its Q3 of 2023. In Q3 2022 they had a revenue of $13.5 Billion and an adjusted net income of $550 Million. This means they had a net profit margin of 4% in Q3 2022, and now they have a net loss margin of 1.5% in Q3 2023. This decline is very significant for the company. They also noted that unit revenue increased 6% YoY in Q3 2023, but unit expenses also rose in line with those numbers, leading to a decline in profitability. The main drivers for the increase in expenses included higher labor costs from the new pilot’s contract, higher fuel costs due to higher oil prices, and an increase in maintenance costs. The company also mentioned that it had $9.1 billion in total available liquidity, consisting of $5.8 billion in cash and short-term investments, and $3.3 billion in undrawn credit facilities.

American Airlines had negative earnings growth from 2004 to 2022. AAL had a return on equity of 22.7% in 2021, which fell to a negative of 56% in 2022. The trend shows how much the industry is unstable. Also, all the earnings that they have generated in their history have been wiped out many times over. Also, during Covid crisis they took on a lot of debt, and therefore, now have to pay a lot in interest payments.

  • Debt: AAL is known for having a very bad debt structure. They have around $50 billion in debt and lease obligations and their current asset are quite low in comparison, making this a dangerous situation. Also, their debt agreements contain covenants that may limit their flexibility to operate the company.

  • ROIC: American Airlines’ return on invested capital has been poor in recent times. While they have been able to achieve profitability in some years, their ROIC continues to show weakness. Airlines are notorious for that. They have a negative ROIC over the past 5 years. Also, the airline industry is an industry with low profit margins. The spread of ROIC to WACC is close to zero. This analysis shows that the company’s strategy won’t be great for their shareholders as they can’t create great value or economic profit.

Understandability Assessment

Although the core business of an airline is simple to grasp, understanding the full financial implications and complexities of the airline industry makes it a difficult business to analyze. Therefore, its understandability rating is low.

  • Complexity of Operations: The airline industry is highly capital intensive, requiring continuous investments in aircraft, facilities, and technology, which makes the financials complicated. Understanding the factors that influence profitability, such as load factors, seat-miles, revenue per available seat mile, fuel prices and fuel efficiency, and capacity are not straight-forward and take time to understand. Additionally, the volatile nature of the market leads to unpredictable fluctuations in revenues. Also, accounting for the industry is quite complex.
  • Regulatory Environment: Airlines are heavily regulated by government agencies, making business models and growth more difficult to understand.
  • Financial Nuances: Airline financial statements can be complex, with significant leverage, complicated balance sheet items, and unusual accounting methods.

Balance Sheet Health

American Airline’s balance sheet is very unhealthy due to substantial debt and large liabilities.

  • High Debt: American Airlines carries a very large debt load, which restricts its ability to respond to adverse economic changes.
  • Low Liquidity: The company also has low levels of cash on hand and short-term investments. They have $9.1 B in available liquidity with a $50 B+ debt.

Risks to the Moat and Business Resilience

  • Intense Competition: Competition is so strong among the existing companies, and low prices make the entire industry unstable. Competitors can easily match their prices, eroding the competitiveness of the business.
  • Cyclical Demand: The industry is highly cyclical; demand for air travel fluctuates due to broader macroeconomic and geopolitical factors. Changes in demand can significantly affect their profitability and overall returns, making them extremely vulnerable.
  • Fuel Price Volatility: Fuel costs are a major expense for airlines, and their prices are very volatile. A sudden rise in prices can decimate a company’s operating profits, even if they have a great performance otherwise.
  • Black Swan Events: The company’s operations have been subject to pandemics, terrorism, and other geopolitical factors that are beyond their control and therefore, are extremely unpredictable in their nature. This makes them very vulnerable and unstable.
  • Labor Costs: Unionized labor agreements are subject to negotiations and could cause material disruption in operations.
  • Dependence on Aircraft: Airlines depend on a number of aircraft producers for their fleet. The fact that there are only two major producers in this space means they have pricing power which leads to additional costs. Also, the delayed delivery of aircraft or any problems with their manufacturing may reduce their fleet capacity, which will affect revenues and profits.
  • Regulatory Changes: The company is highly regulated by different countries, and changes in those regulatory frameworks can influence their operations and profits.

Conclusion

American Airlines is facing significant headwinds because of its heavy debt load, lack of pricing power in a commoditized market, highly unstable and cyclical industry and high operating costs. It would seem like there are very little reasons to invest in it or hold it. The management has noted these problems and has tried to put a plan in place to bring the profitability of the business back, but these changes will take time and are extremely uncertain.