Can American Airlines Afford $15 Billion Worth of New Planes?
By Shubh Datta
July 8, 2011
Top aircraft carriers in the US are looking to overhaul their fleets. In the face of high gas prices, these carriers are planning to replace their old fuel-guzzling planes with newer more fuel-efficient aircraft.
Not to be left behind, American Airlines parent AMR (NYSE: AMR ) is planning to shell out close to $15 billion to reinvigorate its fleet with narrow-bodied craft.
Re-fleeting the hangars
The nation’s four largest carriers are all looking to add more aircraft to their hangars. Media reports quoting sources said American is planning to buy close to 250 narrow-bodied planes, splitting the $15 billion that it plans to spend between aircraft makers Boeing (NYSE: BA ) and Airbus.
Even the world’s largest aircraft carrier Delta (NYSE: DAL ) is planning to add close to 200 new aircraft by the end of the year. To complete the list, Southwest (NYSE: LUV ) and United Continental Holdings (NYSE: UAL ) are also mulling over adding new planes to their fleet.
The airline industry in the US is currently coming out of a long year in which it has had to face the pressures of high gas prices, capacity cuts, and consolidation in the industry. These factors led to a drop in American's revenues and bottom line and weighed on its financial position.
A look at the numbers
Unfortunately, AMR’s numbers don’t make for pretty reading. Though LTM revenues have increased by 12% to $22.63 billion, costs have shown a simultaneous jump, rising 7% to $17.44 billion. No wonder then that American reported losses of $402 million in the last twelve months.
From a balance sheet perspective, American’s free cash flow stands at a negative $622.3 million. American’s current ratio stands at 0.9 times, which means that it is not in a comfortable position to pay off its short term liabilities. Its interest coverage ratio stands at 1.9 times, hence the company is reasonably placed to pay off its obligations but is not in a comfortable position to assume further debt. The burden clearly can be understood, when we see that American’s total debt has risen to $12.1 billion in the last twelve months.
A string of losses have taken their toll on the balance sheet and the company needs help to finance this huge, $15 billion endeavor. Hence, the deal would require substantial financing from the manufacturers or leasing companies. Just where will the money come from? Given the industry’s volatile nature, I’m not going to be the first one to jump in line to finance this massive project.
The major question here is whether or not American Airlines will choose Boeing or Airbus aircraft? According to reports, American first approached Airbus without informing Boeing (who currently supplies planes to American) and was happy with the offer it had made. Later, it approached Boeing, possibly throwing down the gauntlet by asking it to better Airbus’ offer.
Airbus has struggled to penetrate the US markets, with US Airways Group (NYSE: LCC ) currently being its biggest customer. Winning the deal would be a huge boost for Airbus. This would be an important step forward as the global passenger airplane market is expected to be worth $4 trillion in the next 20 years.
Despite the deals’ massive price tag, it’s a necessary one. The purchase should eventually translate into lower costs. It should mean lower maintenance costs and considerably lower fuel costs. Plus, planes just need to be replaced.
The Foolish bottom line
If American Airlines can work out the finances and the deal goes through, it will help position the company for the next decade of transcontinental business. As an investment, however, this is not the type of news that gets me excited. Show me a few quarters of strong financial performance and then maybe we can talk.