Why Hedge Funds Are Crazy About American Airlines Group

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 |  About: American Airlines Group (AAL)
by: Javier Hasse

Summary

Hedge funds are showing themselves increasingly bullish in relation to airline companies, especially about American Airlines Group.

Following the merger with between U.S. Airways and American Airlines, American Airlines Group is particularly well positioned to compete in the industry.

While growth potential is plenty, valuation is still attractive.

Airline stocks are well known for offering great rewards to shareholders willing to take the relatively large risk of investing in the constantly fluctuating industry. Despite the uncertainties, hedge funds are increasingly confident in this sector, mainly due to solid performances on Wall Street over the past two years. Hedge funds are particularly bullish regarding American Airlines Group (NASDAQ:AAL).

Well-executed merger leads to more efficiency

The company was formed by the merger between U.S. Airways and American Airlines in December of 2013, and has been delivering solid results ever since. Yet strong cash flow levels, and increasing revenue, are not the only reason why hedge funds such as John Paulson's Paulson & Co, David Tepper's Appaloosa Management LP, and James Dondero's Highland Capital Management are buying up shares.

Apart from being one of the three largest network carriers in the U.S., American Airlines has become increasingly efficient, thanks to the smooth integration following the merger. The company has improved significantly in dealing with energy price spikes, especially thanks to its high capacity and strong pricing power. Passing costs on to passengers without affecting sales negatively is not only important for the present, but can assure investors remain confident in the long-term.

Expansion and modernization

Along with more efficient management, American Airlines is currently engaged in modernizing its fleet and expanding its routes. The expansion of its network to China, where the company now operates five flights daily, is especially encouraging. The China-U.S. route is growing in terms of air traveler traffic, while it remains one of the most profitable routes worldwide. Hence, expanding its share of this air traffic market will be one of the firm's main objectives going forward, as it seeks to compete not only with its U.S. counterparts, but also with Chinese airliners.

In order to outperform competitors, American Airlines has begun with the modernization of its fleet. The firm is expected to increase passenger revenue per available seat, thanks to larger seating capacity and better fuel efficiency. The installation of additional seats in the MD-80 aircrafts has already been successful, with additional aircraft fleets following suit. Overall, expansion into new markets and more efficient aircrafts, have given hedge funds even more reasons to feel bullish about American Airlines.

Price discount and future buyback program

The most attractive feature of American Airlines' stock is surely its price. Trading at $38.36 per share -as of August 4th 2014, the stock is available at a significant price discount relative to its industry peers. In addition, the announcement of the first dividend payout in 34 years is an important indicator of excess cash. Not only is American Airlines rewarding shareholders with dividends, but a stock buyback program is also likely to be implemented soon. Considering that the company holds around $10 billion in cash, analysts are almost certain that buybacks will be considerable, driving earnings per share to new heights. Thus, hedge funds' bullish stance towards the stock is more than justified.

Hedge funds are on the right track

Despite a solid performance in 2014 and hedge fund backing, American Airlines could still face trouble ahead. Oil prices remain a constant risk factor, despite the company's improved ability to mitigate the effects of energy price spikes. Nevertheless, the bullish stance hedge funds have taken towards the stock is more than reasonable. Investors looking to place their money in the airline industry should definitely follow suit while shares remain undervalued. The forecast for 2014 has AAL earnings up by $5.21 per share, and with a buyback program on the horizon, investors could see stock prices rise even further. In addition, a buyback program would strengthen EPS in the long-term. Hence, with a great performance throughout 2014, expansion into new markets accompanied by fleet modernization, and estimates forecasting high returns, American Airlines is a great investment option.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.