<p>From the perspective of American Airlines (NASDAQ: AAL), Federal Reserve Chairman Jerome Powell may just as well be a god. A little more than a week ago, Powell stated that he will “act appropriately” to maintain the economic recovery. It immediately sent the AAL shares because it meant more inflation, which would theoretically reduce the underlying company’s debt burden.
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The day after Powell sent in his accommodating intentions, the government released the work report in May. Frankly, it was fantastic and revealed that the economy provided 2.5 million jobs. It was not only a confirmation that the worst was behind us, it was also a rejection of the many predictions of doom and gloom that preceded the report. This also gave the AAL share a real boost.
But recently, the Fed chairman played the role of killjoy. Despite encouraging labor market dynamics, Powell warned that the economy was facing “a long road” to recovery. And the day after this heated discussion, the Ministry of Labor revealed that 1.54 million workers submitted their first unemployment claims. Although some of these figures reflect delays due to mass overruns in previous weeks, the figure still stubbornly high indicates that financial pain is spreading to several job categories.
Powell gives and he takes away.
Of course, it’s not fair to dump everything on him. First, competition, including United Airlines (NASDAQ: UAL) and Delta Air Lines (NYSE: DAL), was hit hard. The painful turn in the AAL population was also a reminder that the bulls had been removed.
For the Fed chairman, the point is not to get over the worst of the crisis. And for American Airlines, it has another problem: math.
A very bad equation obscures AAL layers
Personally, I find the subject of airliners during the pandemic era fascinating. Few industries reflect the link between real-time fundamentals and technical enthusiasm, just like the airline’s shares. Maybe investors dived deep into the discount basket on a misleading story.
Anyway, I think some mental issues will soon return to this sector. When it does, I would not want to be too delivered to the AAL share.
Simply put, the math is extremely unfavorable for American Airlines and almost all of its competitors. Even in the best of times, AAL’s operating margins became razors – not that they were ever large. But in 2019, the passenger volume reached 926.4 million for those boarding the United States. Yet during that year, American Airlines’ operating margin was only 8.07%.
Of course, the new coronavirus has completely broken out the travel industry paradigm. And here it gets ugly for AAL shares. If we assume a best case – that is, the flight capacity jumps directly back to the 2019 levels immediately – the total passenger volume would come in at the end of the year to an astonishingly low 733.5 million.
In such a situation, I see AAL generating about $ 27.3 billion in revenue. This assumes that the company maintains its market share of 17.5% and its revenue of $ 212.70 per passenger. If this is the case, an adjusted cost for goods sold, together with an assumed operating cost of 75% compared with 2019, gives an operating margin of just under 4.1%.
This is a best case for AAL shares. But aviation experts predict a 52% reduction in global aviation demand from 2020’s forecast before the pandemic. In that case, we can see the US passenger volume fall to 440.5 million by 2020.
Worryingly, this could lead to AAL’s operating margin falling to around 2% or lower.
The room closes
Let me warn the above by saying that you should not take my numbers as gospel. Several variables go into profitability margins. In the end, the actual figure may be lower or higher. But what I am trying to do is give you a picture of what you can expect for AAL shares.
What all investors should worry about, however, is the forecast for passenger volume for the rest of the year. Again, in the absolute best case scenario, you are looking at 733 million American passengers, which is close to the great recession level. However, I think the expert forecast scenario of 440 million is very realistic.
But the craziest thing is that it’s somehow awful for AAL shares. Along with cutting down on everything they can reasonably do, management must also be able to handle a very poor balance sheet. Basically, the longer this drought continues, the more mathematics works against American Airlines.
If that was not enough, the external fundamentals are hardly supportive. For example, nationwide protests have likely reduced consumer demand for travel. Furthermore, we are seeing an increase in cases of coronavirus, which is exactly what this industry does not need.
So whether you’re a number-based investor or a story-based investor, it’s the same story. We’re just discussing how ugly the end will be.
Josh Enomoto, a former senior business analyst at Sony Electronics, has helped broker larger contracts with Fortune Global 500 companies. In recent years, he has delivered unique, critical insights for the investment markets, as well as for various other industries, including legal, construction management and healthcare. At the time of writing, he had no position in any of the above-mentioned securities.