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American Airlines: Inadequately Prepared Due To Share Buybacks

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About: American Airlines Group Inc. (AAL)
by: Daniel Thurecht
Daniel Thurecht
Long-term horizon, contrarian, oil & gas, industrials
Summary

Since reemerging from their last bankruptcy, American Airlines has aggressively pursued returning cash to their shareholders primarily through share buybacks.

Whilst there is nothing necessarily wrong with share buybacks, they should not be conduced when the company in question does not generate free cash flow and is already leveraged.

Due to these shareholder returns, their financial position is considerably more leveraged and thus their ability to mitigate any rough economic times is significantly diminished.

Introduction

Since reemerging from bankruptcy earlier this decade, American Airlines (AAL) has been aggressively pursuing shareholder returns; however, despite these actions, their share price has still fallen over 40% during the last two years. Unfortunately, these shareholder returns have come at the expense of maintaining a strong financial position and thus they once again seem inadequately prepared if economic conditions were to turn negative.

Cash Flows & Debt

Thankfully, the graphs largely speak for themselves, with the first two graphs included below summarizing their cash flows and debt from the last seven years:

American Airlines cash flowsAmerican Airlines notes 1

Image Source: Author.

Throughout the last seven years, they have seldom produced any positive free cash flow, and even when this occurred, it was minimal when compared to the years where it was negative. Since the beginning of 2013, their free cash flow has totaled negative $5.716B, meanwhile they still returned a further staggering $13.85B to their shareholders through a combination of dividends and share buybacks. Naturally, this was entirely funded through debt as their net divestitures of $2.938B were still dwarfed by their negative free cash flow and thus were incapable of funding any of their combined shareholder returns.

American Airlines cash and debtAmerican Airlines notes 2

Image Source: Author.

Given their aforementioned financial performance and questionable shareholder returns, it should come as little surprise that their net debt has expanded quickly, rising 165.83% since the end of 2013. The only positive consideration being that their cash balance still sits relatively high and thus helps provide a degree of liquidity; however, as subsequently discussed, this alone is not necessarily enough to ensure their ability to weather tough financial times.

Financial Position

Since their free cash flow has rarely been positive, it is especially important to consider their financial position. The graph included below summarizes their financial position from the last three years:

American Airlines leverage ratiosAmerican Airlines notes 3

Image Source: Author.

It quickly becomes apparent that their financial position remains weak, with all these metrics indicating their ability to service their current debt is reaching around their upper limits. Whilst this would not be concerning if economic conditions remain broadly supportive, serious risks lay dormant waiting to rear their head when this economic cycle turns negative. Considering the mounting global economic risks, from the trade wars to high global indebtedness and rising populism, this certainly is worthwhile considering.

There is nothing necessarily wrong with shareholder returns in general; however, they should be conducted when the company is over-capitalized, not when it is struggling to generate free cash flow and already has a leveraged financial position. Even though their shareholder returns have slowed significantly in the recent years, the fact they are still continuing at any rate is concerning and continues to diminish their ability to weather any economic storms that could eventuate.

If none of these shareholder returns were ever pursued, their net debt would be an impressive 69.00% lower and thus their net debt to EBITDA would be much safer at only 1.23 instead of a highly concerning 3.95, meanwhile their current ratio would soar to 1.20. A financial position with this strength would completely change their ability to endure sudden negative financial conditions and could have simply been achieved through avoiding borrowing to fund shareholder returns.

Conclusion

Whilst no one can predict with certainty when tough economic times will arrive, the fact of the matter is that they have chosen to focus on short-term shareholder returns instead of ensuring the long-term financial viability of their company. To make matters even worse, the majority of their shareholder returns have been share buybacks, which are effectively retained within the company, and thus, if things go south, their shareholders will still be left high and dry. A highly economically sensitive company that is operating in an industry known for bankruptcies that has been borrowing to fund share buybacks does not sound like a particularly desirable investment.

Notes: Unless specified otherwise, all figures in this article were taken from American Airlines’ SEC filings, all calculated figures were performed by the author.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.