American Airlines leadership knows they have a debt problem. That’s why the carrier is aggressively repaying its obligations with an unexpected payment of more than $1 billion this week. Merry Christmas Wall Street.
The Fort Worth, Texas-based airline repaid early a $1.18 billion term loan backed by its slots at New York LaGuardia and Washington Reagan National airport Monday, according to a filing with the Securities & Exchange Commission. The debt was not due for another year, or until December 2023. And the payment was unexpected after American Chief Financial Officer Derek Kerr said in October that the airline would only repay roughly $540 million in debt during the December quarter.
Despite the news, American remains one of the most leveraged major U.S. airlines and, while not necessarily in jeopardy, on many analysts’ lists of companies with high debt loads.
American had $34 billion in long-term debt and finance lease obligations, excluding debt that is due within 12 months, at the end of September. That number balloons to nearly $53 billion when including all liabilities, including unfunded pension obligations. Much of that leverage came from its fleet renewal program during the 2010s that saw it replace hundreds of older Boeing 757 and 767, and McDonnell Douglas MD-80 aircraft, with new Airbus and Boeing models. American’s long-term debt and finance leases load was down from a pandemic peak of $37.2 billion in the first and second quarters of 2021, but up $12.5 billion from the end of 2019.
Comparatively, Delta Air Lines had $21.2 billion in non-current long-term debt, and United Airlines $28.6 billion at the end of September.
“Reducing total debt continues to be a top priority,” Kerr said in October. The airline targets $15 billion in debt reduction from its 2021 peak, or to roughly $22 billion, by the end of 2025.
All of that is well and good for credit analysts, but not enough to lift American from anyone’s leverage list. J.P. Morgan analyst Mark Streeter wrote earlier in December that the airline “will remain in focus” in 2023 due to its high debt load. He specified that American was not considered a restructuring risk currently because it also maintains a high level of liquidity commensurate with its debt load.
American had $14.3 billion in liquidity available, including cash, cash equivalents, and revolver capacity, at the end of September.
The airline also benefitted from $12.8 billion in payroll support funds from the U.S. government under the CARES Act Covid relief packages. Payroll support does not need to be repaid. American also borrowed another $550 million from the U.S. Treasury under a $25 billion CARES Act loan program for airlines; it repaid those funds and terminated the credit agreement in March 2021.
The question facing American, however, is what happens if air travel demand tanks and it is unable to maintain those liquidity levels. Few expect this to happen — U.S. airline CEOs have repeatedly said travel demand remains robust despite an uncertain economic picture — but, in the world of business, worst case scenarios must be considered, especially given the airline’s debt levels. American, for its part, expects the string of profits that began in the second quarter to continue in 2023.
“The leveraged airlines better hope that cash is available to repay debt because the cost of refinancing debt is now sky high,” Streeter wrote. He referred to the U.S. Federal Reserve’s recent rate hikes that have significantly increased the cost of borrowing; especially when compared to debt that was borrowed when rates were at historic lows during the Covid crisis.
Kerr, in October, acknowledged the rise in the cost of capital. Higher rates had increased American’s average interest rate by about 1 point to roughly 5 percent, or about $40 million in additional expense in the fourth quarter compared to the third, he said. However, those same rate hikes have increased the carrier’s returns on the cash it holds in the bank that effectively neutralizes the additional expense.
American anticipates hitting the halfway point, or $7.5 billion, of its 2025 debt repayment target by the end of the year. That includes $5.6 billion already repaid at the end of September, the payment Monday, plus the $540 million in planned December quarter debt payments outlined in October.
That’s a good place for American to be sitting as the industry enters an uncertain 2023, even with travel demand seeming to continue unabated. If demand does not turn out as expected, or there is a — highly likely — unexpected surprise, the airline can push off the balance of its deleveraging until the economic situation looks brighter again in either 2024 or 2025.
But Kerr, who has managed American’s books since its merger with US Airways in 2023, will not be there to see the deleveraging through. He steps down as CFO at the end of the year with Devon May, the airline’s senior vice president of finance and investor relations, replacing him.
“We have to be profitable in order to really serve the needs of our communities, our customers and the shareholders of this company,” American CEO Robert Isom said in October. “We’re intent on doing it, and we’re going to make sure that this airline is one that you can count on in terms of producing profits, ultimately reducing debt over time and being sustainable from a profitability perspective.”