Seeking Alpha
Growth at reasonable price, long-term horizon, research analyst
Profile| Send Message|
( followers)  

On the first day of trading, December 9, 2013, for the new American Airlines (NASDAQ:AAL), formed by the merger between US Airways and the old American Airlines, I wrote an article to recommend its shares. (The article actually appeared a few days later because this was my first article on Seeking Alpha so that it took some time to work out the editorial and formatting issues.) Since then, the stock price of AAL has moved up very nicely, together with the entire airline industry, from $24.6 on December 9, 2013, to $31.96 on January 28, 2014, when AAL reported its earnings for the latest quarter. This is about a 30% gain in less than two months of time. Because of this, I thought an update on AAL would be appropriate.

Tail Winds Still On

I discussed many favorable trends in my last article on AAL, some of which are industrial wide and others are AAL specific. These trends are largely intact and will be the driving forces to propel AAL's shares higher. These trends have also been written about in other articles, including some in Seeking Alpha, so that I will only briefly summarize them here. For the entire airline industry, the favorable trends are

· Global economic recovery to support healthy growth for air travel

· Consolidated industry to give the airlines pricing power

· Improved business model of the airline industry to ensure profitability

· Better fleet capability management to control cost

For AAL, the attractive features include

· Combination of vast domestic network and extensive international routes

· Appeal to business travelers, the most profitable segment of the industry

· Potential for significant merger-related cost savings

· Huge revenue base of more than 100 million frequent flyers

· Attractive valuation compared to other airlines

Latest Quarter Results

The earnings results for the latest quarter were reported yesterday, January 28, 2014, and are summarized in the following table.

Revenue

Earnings Per Share

Reported

$9.98 Billion

$0.59

Expected

$9.90 Billion

$0.55

Beat

0.81%

7.27%

The results certainly reflect the strong business environment and the strength of the company. It should be pointed out that these results are very similar to those reported by other airlines, such as Delta Air Lines (NYSE:DAL), United Airlines (NYSE:UAL) and Southwest Airlines (NYSE:LUV). Thus, they are largely due to the favorable industry-wide trends. In other words, the strong results reported by AAL are mostly due to the strength of the two individual components of the merged company, namely, the old US Airways and the old American Airlines, and the benefits of the merger-related features of AAL are yet to be realized. This is expected because the new company only had less than two months of time so far. I believe that the attractive features of AAL will propel its shares higher as the integration of the merged companies moves along.

Valuation Update

With the results for the year 2013 reported and the stock prices significantly up in recent weeks for the major companies in the airline industry, a valuation update is given in the figure below, which plots the price-to-earnings ratios of the major airlines, including AAL, DAL, UAL, LUV, as well as JetBlue Airways (NASDAQ:JBLU). The P/E values are computed by using the closing prices on January 28, 2014, and the projected annual earnings for 2014, respectively, for the companies in the group. Clearly, AAL is noticeably cheaper than others based on the P/E ratio metric.

The stock market awards AAL a much lower P/E than the others, probably because investors anticipate some challenges in integrating the two merged companies. This is fully understandable. On the other hand, if AAL management makes good use of its experience in integrating US Airways and American West after their 2005 merger, and learns from the more recent mergers (United and Continental, Delta and Northwest), there is no reason to expect AAL to mess up the integration. In this case, AAL will catch up with the rest of the group in P/E values and this gives a reasonable way to quantify the future potential of AAL's price appreciation.

Target Price for AAL

By assuming the average P/E ratios for AAL and using its 2014 projected earnings, the target prices for its shares are listed in the table below. To be more relevant, two values of group average in P/E are given, one for the two companies UAL and DAL and the other for the whole group. This is done because I think UAL and DAL are very similar to AAL so that the use of the two should be more relevant. In this case, the average P/E of UAL and DAL is 11 which leads to the target price of $39 for AAL, a 22% appreciation from its current price of $31.96. This seems to be consistent with some published target prices, which are also listed in the table, including those by Hunter Keay of Wolfe Research Inc., Jamie Baker of JPMorgan Chase & Co., both quoted from Bloomgerg, Bob McAdoo and Scott Buck of Imperial Capital, and the average pooled by Yahoo Finance. For comparison, the target price of $45 based on the average P/E of the entire group, namely, UAL, DAL, LUV and JBLU, is also given in the table, which implies a 41% gain. It should be pointed out that this comparison may be a little less relevant because LUV and JBLU are less similar to AAL.

Basis

Group Average P/E

AAL Target Price

Appreciation

UAL and DAL

11

$39

22%

UAL, DAL, LUV and JBLU

12.7

$45

41%

Hunter Keay, Wolfe Research Inc.

$39

22%

Jamie Baker, JPMorgan Chase & Co.

$36

16%

Bob McAdoo and Scott Buck, Imperial Capital

$36

13%

Average, Yahoo Finance

$34

6%

Summary

AAL has appreciated about 30% since it started trading as a merged company less than two months ago. This appreciation may be justified by the strong business results reported today. However, the positive results seem to be mostly due to the favorable macro trends for the airline industry and the strengths of the individual pre-merger companies. Thus, further upside growth can be expected once the benefits of the merger are realized. The valuation of AAL, based on the P/E ratio, seems to support this.

Source: An Update On American Airlines