AMR Files For Bankruptcy, What Happens Next?

| About: American Airlines (AAL)
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As expected, AMR Corp. (NASDAQ:AMR), the parent of American Airlines, filed for bankruptcy protection Tuesday. We had been expecting the demise of the carrier as we outlined to our subscribers here. We encourage investors to not dabble in the firm’s shares after the filing today, as it is extremely likely that the shares will be canceled (meaning current holders get nothing).

It turns out we got an answer to our rhetorical question, “Is AMR’s Equity Practically Worthless,” sooner than we had expected. View our May call on AMR’s demise here. The firm flashed a 1 on our Buying Index in May – July, which is the lowest possible ranking on our stock-picking scale. During bankruptcy, AMR will renegotiate with its unions to capture cost savings, optimize its fleet by breaking free of leases, and force haircuts on its debt load. Plus, the filing today helps to protect AMR's current cash load, which would have diminished further if it pushed off the filing.

We expect AMR to emerge as a stronger and leaner carrier once restructuring is complete. In the near term, we view this as a positive for legacy competitors: US Airways (LCC), Delta (NYSE:DAL), United Continental (NYSE:UAL) and Southwest (NYSE:LUV). AMR likely will cut capacity - unprofitable routes - during the Chapter 11 process, and this will be a meaningful positive on industry yields (at least in the near term and assuming the bankruptcy process is not prolonged and ticket fares aren’t slashed while under creditor protection to generate cash flow). However, AMR will become a stronger airline once it emerges, with a lower cost structure. So over the long haul, the filing is a negative for its network peers from a competitive standpoint. US Airways, Delta, United Continental and Southwest would have preferred AMR to remain outside of the bankruptcy process, as the move today is the only answer for AMR to become a competitive threat.

We don’t expect a wave of bankruptcy filings by airlines following AMR’s, though we highlight US Airways as the weakest link. US Airways, a proponent of consolidation, has largely missed out on its attempt to merge with a larger carrier in previous years (and its U.S.-heavy exposure is somewhat concerning). It did acquire America West a number of years ago, however. Interestingly, we could see US Airways become active in AMR’s bankruptcy process, scooping up some debt and forcing a merger between it and American during Chapter 11 proceedings.

Merging during Chapter 11 is the best way to tie-up in the airline industry, in our opinion. Combining operations while one carrier is under bankruptcy protection allows for significant flexibility, as both entities (in this potential case US Airways and AMR) could optimize their route networks and fleets, while ensuring that the lowest cost structure can be achieved. Plus, it would allow for the reduction of overhead and redundant expenses.

We would be an advocate of AMR tying the knot with another carrier during its bankruptcy. We continue to monitor developments on this front and, as a general rule, encourage investors to continue to steer clear of the airline space.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.