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Shares of American Airlines Group on Monday bounced off a record closing low, but underperformed the big rally in the broader stock market, after J.P. Morgan analyst Jamie Baker swung to bearish from bullish,citing expectations of a drawn-out post-COVID-19 recovery with such high debt levels implies a “negative” equity value.
Baker downgraded American to underweight from overweight, saying that while he’s not implying that the airline has been “mortally wounded” by the COVID-19 related disruptions, “our view on aggregate bankruptcy risk…has not doubt evolved in recent weeks,” as the need for material downsizing has increased. He also withdrew his stock price target.
Shares of American Airlines Group Inc. AAL, +0.20% rallied 3.6% in midday trading, after seesawing between an intraday gain of as much as 5.9% and a loss of as much as 3.0%. The stock closed at a record low of $9.39 on Friday. Meanwhile, the U.S. Global Jets exchange-traded fund JETS, +3.64% surged 5.0% and the S&P 500 index SPX, +5.71% shot up 5.6%.
“In our opinion, the margin for error for American management to navigate this crisis outside of the courts is growing uncomfortably thin (and dependent on factors outside of management control, i.e. duration of the virus, traffic recovery cadence, further government support) that we really don’t think we’re left with a choice but to downgrade our credit opinion on American as well, to underweight (from our prior neutral on the credit side),” Baker wrote in a note to clients.
Baker said what has changed recently is that he had been expecting the airline industry recovery in 2021 to be “within sight” of 2019 results, but that is no longer the case.
He now expects second-quarter 2020 revenue will be down 80% from a year ago, third-quarter revenue will be down 45% and fourth-quarter revenue will be down 25%, which is roughly 10 percentage points worse than previous expectations for each period.
For 2021, Baker projects revenue will be “no better” than approximately 25% below 2019 levels.
“We are growing increasingly convinced that industry recovery to 2019 levels of output will be a multiyear affair, resulting in the material shedding of aircraft and head count along the way,” Baker wrote.
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For American, he said a 75% recovery in 2021 and about $10 billion in additional debt would require a “greater than a 7X multiple” to drive even a “slightly positive” equity value. However, Baker said “such a valuation appears unlikely to us,” and therefore his current assumptions imply “negative equity value.”
In comparison, the current FactSet 2021 revenue consensus for American of $41.84 billion is 8.6% below 2019 revenue of $45.77 billion.
Meanwhile, Baker said he had previously assumed that airlines that accepted federal grants as part of the CARES act would be allowed to use proceeds to pay labor expenses after Sept. 30. But Baker said that after the U.S. Treasury Department disclosed late Friday that it was considering whether those receive grants could use the funds for labor expenses beyond Sept. 30, his assumption was now at risk.
“Such a prohibition would prove detrimental to liquidity,” Baker wrote.
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Baker also downgraded Spirit Airlines Inc. SAVE, +1.80% to underweight from overweight and both JetBlue Airways Corp. JBLU, +5.28% and Southwest Airlines Co. LUV, +1.01% to neutral from overweight, while upgrading Alaska Air Group Inc. ALK, +8.84% to overweight from neutral. He maintained his overweight ratings on United Airlines Holdings Inc. UAL, +6.06% and Delta Air Lines Inc. DAL, -0.77%
Despite the other airline downgrades, Baker said he was focused on American in his research note to clients “simply because it is the most leveraged major airline” that he covers.
American’s stock has tumbled 66% year to date, while the airline ETF has shed 59% and the S&P 500 has slid 19%.
