While rivals such as Delta Air Lines (NYSE:DAL) have worked hard to balance capital spending discipline with the need to update their fleets, top U.S. airline American Airlines (NASDAQ:AAL) has spent freely on new aircraft in recent years. Between 2014 and 2017, American’s capex totaled a whopping $23.1 billion, nearly as much as its current market cap. The vast majority of that spending went toward new planes.
As a result, American Airlines has the youngest fleet among major airlines — but also by far the most debt. Management shows no sign of becoming more frugal in the future. Instead, the carrier recently confirmed that it will replace 45 of its older Boeing (NYSE:BA) 737-800s by the end of 2020, even though these planes should have at least five to 10 years of life left in them.
American Airlines takes on debt to upgrade its fleet
Since the American Airlines-US Airways merger closed in late 2013, the combined company has replaced hundreds of planes, including roughly a third of its mainline fleet. American Airlines generated plenty of cash flow during this period, because of favorable industry conditions. However, the company chose to spend most of this cash on share buybacks, while paying for the fleet upgrades with massive debt issuances.
This strategy has caused Americans’ debt burden to balloon from $16.8 billion at the end of 2013 to $25.3 billion by the end of 2017. (It has also used up more than $4 billion of its cash and short-term investments during that period.) Meanwhile, profitability has receded in each of the past two years and could fall further in 2018.
By contrast, Delta Air Lines has routinely produced stronger margin performance than American Airlines since 2016, while holding its debt below $10 billion.
With profitability plunging and interest rates creeping up, it would seem prudent for American Airlines to cut capex as much as possible so that it can focus on paying down debt. Indeed, Americans’ scheduled debt maturities average more than $3 billion annually between 2018 and 2021. However, while capex will decline in the years ahead, management is still spending more than necessary on new aircraft.
The new aircraft obsession continues
American Airlines’ January investor update indicated that the carrier’s fleet of Boeing 737-800s would decline from 304 today to 259 by the end of 2020. That said, airline fleet plans often assume that all leased aircraft will be returned at the end of the lease term, even though the leases are often renewed.
Yet that’s not what is happening here. American Airlines really does plan to remove 45 older Boeing 737s from its fleet by the end of 2020, according to a recent Bloomberg report. The carrier will also retire all of its remaining Embraer E190s, Airbus A330-300s, McDonnell Douglas MD-80s, and some of its older Boeing 757s during this timeframe.
The MD-80s and 757s are older, 1980s-era designs that have higher fuel and maintenance costs than modern aircraft. The E190s and A330-300s both make up subfleets that are too small to operate efficiently. Replacing these planes makes sense.
By contrast, the Boeing 737-800 entered service in 1998. Even American Airlines’ oldest 737s are just 19 years of age. Meanwhile, Delta frequently keeps aircraft until they are 30 years old, enabling it to hold down capex. Retiring Boeing 737-800s in the next few years is just wasteful.
This isn’t capex discipline
American Airlines executives have frequently noted that capital spending will be significantly lower in 2018 and beyond, relative to the past few years. That said, American plans for capex to average more than $4 billion a year between 2018 and 2020. This is still quite a lot of money for a company that only generated $4.7 billion of cash from operations in 2017.
Most of this capex relates to the 56 Boeing 737 MAX 8s and 50 Airbus A321neos that American Airlines will receive between now and 2020. Given the massive backlogs for these models, it wouldn’t be difficult for American to defer some of these deliveries if it wanted to keep operating its 737-800s.
Instead, American Airlines is poised to continue its free-spending ways. With annual capex of more than $4 billion and pension contributions increasing, the company will have little or no cash available for debt reduction between now and 2020. This situation will leave American Airlines extremely vulnerable during the next industry downturn.