Airlines' survival determined by liquidity
Asked last month how long American Airlines Inc. and other carriers can keep losing money before they run out of time and cash, AMR Corp. chairman Gerard Arpey had a short, glum answer.
As the U.S. airline industry piles up quarter after quarter of huge losses, it's a question that investors and analysts have been pondering as well. The flow of red ink is draining the financial liquidity from a number of U.S. airlines, weakening their balance sheets.
"The availability of capital will largely determine the industry's size, shape and profitability next year, in our view," J.P. Morgan airline analyst Jamie Baker warned investors in a July 20 report. "Oil & revenue warrant attention, but from here it is largely a question of what the liquidity-challenged can accomplish."
Amid concerns about cash drain and future prospects, Standard & Poor's Rating Services has placed three major airline companies – AMR, United Airlines Inc. parent UAL Corp. and US Airways Group – on credit watch with negative implications, with a ratings downgrade possible.
Even the darling of the ratings agencies, Southwest Airlines Co., has seen its credit ranking knocked down three levels by Moody's Investor Services, with the most recent cut in late July. Fitch Ratings also cut the carrier's ratings then.
While Dallas-based Southwest remains the only major carrier with an investment-grade credit rating, its balance sheet, like most carriers', has deteriorated as its earnings have fallen.
Southwest reported a profit of $54 million in the second quarter – after three quarters of losses – but warned that it cannot predict a profit for the third quarter because of falling demand and uncertain fuel prices.
Fort Worth-based AMR lost $390 million in the second quarter and has lost $2.8 billion since the beginning of 2008.
Arpey didn't want to speculate last month about how long AMR could hold out in the current economy.
"We've got a proven track record of meeting our obligations and dealing with difficult environments, and we have degrees of freedom that some of our competitors do not," he said. "How all that plays out remains to be seen."
Who's running short
In evaluating airline finances, analysts look at how much unrestricted cash and short-term investments a carrier has in its treasury compared with how much operating revenue it brought in during the previous 12 months.
Under that criteria, the worst-off companies would be UAL, AMR and US Airways. As of June 30, the cash available for both AMR and US Airways was at 13 percent of revenue while UAL was close by at 14 percent. By comparison, Alaska's cash pile, while smaller, was 32 percent of its revenue between July 1, 2008, and June 30, 2009.
AMR estimates that it has $3.7 billion in unencumbered assets and other sources of liquidity, with more becoming available as it pays off debt in the second half of 2009.
The company has also shown that it can raise capital. In early July, AMR raised $520.1 million from an aircraft financing, and in late July it borrowed another $276.4 million secured by aircraft.
AMR has taken other steps this summer to relieve the financial strain caused by $10 billion in losses since 2001.
In late June, it persuaded creditors to loosen the financial covenants on a $433 million bank loan, and in July it got more favorable terms from a major credit card processor.
Industry analysts expect AMR to gain another big cash infusion by selling frequent flier miles in advance to its credit card partner, Citigroup Inc., with one analyst projecting it could raise as much as $1 billion.
Analysts appear encouraged by AMR's recent success in easing financial obligations and raising money.
Vicki Bryan, debt analyst at Gimme Credit, complimented AMR's management as among the airline executives who have been "very scrappy" and creative in raising more capital.
"I think the industry is overdoing the bankruptcy projection for American," she said.
The trends for the economy and the travel industry appear to be improving, and "I wouldn't write off this management team's commitment to staying out of bankruptcy," she said.
Who can borrow
The knock on US Airways hasn't been its debt load as much as the small amount of collateral it could put up to raise money.
Baker of J.P. Morgan wrote in a July 23 report that AMR's and UAL's borrowing power, as well as their need to borrow, "significantly exceeds that" of US Airways.
"Put another way, AMR needs to borrow a lot of money, and we think it has plenty of ways to do so. United needs to borrow less, and we think it also has a few bullets left to fire in the capital-raising gun," Baker said.
US Airways' "near-term needs are arguably low," Baker said. But he warned that "its capital-raising options appear largely nonexistent if demand trends simply bump along from here or in fact worsen."
US Airways chairman and chief executive Doug Parker told analysts last month that the airline has sufficient cash as a cushion and doesn't see any need to raise more capital to make it through the end of the year. But the carrier will do what's necessary to stay out of financial trouble, he said.
"The problem with those doomsday scenarios is they assume we just sit here and let it happen," Parker said, "and I can assure you that is a bad assumption."
UAL officials also sought during their July earnings call to reassure investors that the company has enough money to ride out the economy and flexibility to get more if needed.
Even so, analysts continue to raise concerns about United Airlines' parent.
"Cost containment is very impressive, in our view, but current revenue run rates are likely severe enough to push UAL to the brink of insolvency," Hunter Keay of Stifel Nicolaus wrote in a July 22 report.
"We are generally pessimistic about a near-term recovery," Keay added. "But if UAL continues to remove fixed costs at the current rate, the capital markets remain accessible, and management continues to act aggressively on ancillary revenues, we believe it buys UAL sufficient time."
Airline debt remains a concern, said aviation consultant Darryl Jenkins.
"The top 10 domestic airlines have more debt than two-thirds of the countries in the world," said Jenkins, who places total debt for the 10 at $50 billion.
Jenkins said the airlines have piled up enough cash and short-term investments to carry them for a while – but they have to begin making money soon.
As a group, "the good news is they're all sitting on cash. The bad news is none of that cash was generated via earnings. It was all borrowed," Jenkins said.
"They have money to get by in the short run, and we haven't any clue when the long run begins."