By Brian Nelson, CFA
Since we published our report May 19 that suggested AMR's (AMR) equity is -- for all intents and purposes -- worthless, the stock has fallen almost 20%, much to the delight of those that bought at-the-money put options at that time. While we maintain that AMR Corp. does have option value (which is why it continues to trade above $0 per share), we think the deck is stacked against the carrier and believe there is more room for the firm's stock price to fall, despite its current liquidity position.
First, we believe the carrier's fleet to be the most inefficient among legacy network peers. Second, we think its cost structure is among the worst in the domestic aviation industry. Third, we believe its fuel hedges in 2012 are minimal -- not unlike the other majors, Delta (DAL), US Airways (LCC), United Continental (UAL) -- but nontheless insufficient to shield it from a crude-oil price spike in spring 2012, as predicted by Barron's in its cover story over the weekend. Fourth, it retains a huge debt load that will only be exacerbated by its efforts to renew its fleet with a potential massive purchase of new narrowbody planes to the tune of about $15 billion. And fifth, its pension liabilities are staggering -- most of its domestic peers were able to shed these obligations during Chapter 11 (bankruptcy) proceedings in the early and middle part of last decade. We thought it bold to make the call in mid-May, as AMR was well off its 52-week lows, but as it breaks into new 52-week lows, we continue to get confirmation of our analysis by the market.
Importantly, for investors betting on the rising price of crude, there are additional compelling plays in the airline space for this. First, the Guggenheim Airline ETF (FAA) provides the opportunity to take a relatively long-term position in put options, which represent a more diversified bet on the downward trajectory of airline market values. Second, our analysis of the hedge positions of the domestic majors presents an interesting opportunity for crude-oil bulls with respect to US Airways.
Despite our somewhat bearish view on airline stocks, we continue to be quite bullish on aerospace suppliers. The build rates of Boeing (BA) and Airbus (OTCPK:EADSY) will expand considerably in coming years as both ramp up production of their narrowbody products (737, A320) in anticipation of looming threats from global competitors -- Bombardier (OTCQX:BDRBF), Embraer (ERJ), Comac from China, and Irkut/UAC from Russia -- and to clear up backlog as they plan for upgraded narrowbody versions of their own. Airbus is pursuing the A320 neo -- new engine option -- while Boeing is most likely to pursue a brand new narrowbody aircraft by 2019-2020.
Since we published our three top picks in the aerospace supply chain June 6, all three have outperformed the market in a big way: small-cap Astronics (ATRO) is up over 30%, nano-cap EDAC Tech (EDAC) is up about 20%, and mid/large-cap Precision Castparts (PCP) is up almost 10% compared to relatively flat performance from the S&P 500 Index. We continue to expect outperformance from these firms, and prefer opportunities in the aerospace supply chain relative to positions in the airframe manufacturers at this time.