American Airlines: Prime Reasons To Own This Airline

| About: American Airlines (AAL)

Summary

American Airlines trades near recent highs, but the stock is far off the 2015 highs.

The airline beat Q2 analysts estimates, but the market is missing a couple of prime reasons the stock should head even higher.

As the industry moves towards reversing the negative revenue trends, watch for the market to turn more positive on the airline sector.

While a lot of people continue seeing warning signs with American Airlines Group (NASDAQ:AAL), the airline generates huge profits and returns capital to shareholders at an exceptional rate.

Source: American Airlines website

The Q2 results highlight the value of the stock and why investors have so many questions whether valid or not. With the stock trading below $36, American Airlines barely scratches the service for value due to a couple of prime reasons.

Prime Reason 1 - Taxes

The market is obsessed with revenue metrics to the point that bottom line numbers don't apparently matter. Sure, revenues were down 4.3% for the quarter, but the airline actually generated a larger EPS this Q2.

While the market is comparing the reported EPS of $1.77, American Airlines actually produced an adjusted EPS increase of $0.19 due to the non-cash income tax charge. The airline ended 2015 with $8 billion in Federal net operating losses to offset tax expenses this year.

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Source: American Airlines Q216 earnings release

The amazing part is that CFO Derek Kerr forecasted in the earnings call that the airline won't become a tax payer until possibly starting in 2019.

Yes, we are thinking right now, 2019 or 2020, but it just depends on also aircraft purchases and other things like that. So, I think we are looking at more '19 to '20 for cash taxes.

The numbers weren't hugely impressive as pre-tax income and pre-tax margins declined from the record levels of last year. As well, American Airlines guided to Q3 pre-tax margins of only 12% to 14%.

At the current stock price, the airline doesn't need overly impressive numbers, though.

Prime Reason 2 - Share Count Reduction

The prime reason American Airlines can generate EPS growth in the midst of margin pressure is the substantial share buybacks. The airline couldn't engage in meaningful share buybacks without huge cash flows and a cheap stock.

For Q2, the airline repurchased 50.2 million shares at a cost of $1.7 billion. American Airlines reduced the share count by 8.5% in Q2 alone. The company has now reduced the share count 29% since the merger from 756.1 million shares to 537.1 million shares.

The diluted share reduction is most visible in the net payout yield concept. The concept adds the net stock buyback yield to the dividend yield for a calculation of the capital returns to shareholders in relation to the market value. The current yield has sat far above 20% for the last few months.

AAL Net Common Payout Yield (<a href=

AAL Net Common Payout Yield (TTM) data by YCharts

With American Airlines not having to pay taxes for a few more years, the company has more cash available for the share buybacks. In essence, investors need to consider the EPS estimate of $5.04 for 2017 is equivalent to essentially earning $8.13 for the year. The company is now recording taxes at a 38% tax rate.

Remember that the stock only trades for roughly $36 right now.

Takeaway

Revenue metrics remain a concern, but the airline forecasts that some of the biggest pressures are now lapping the big hits from 2015. With Brazil and the Dallas Love Field areas turning more neutral, the market can now get back to the profit picture at the airline. The credit card deal and product segmentation plans provide upside potential for next year.

In essence, the stock trades at roughly 4.5x forecasted cash earnings for 2017. American Airlines remains too cheap even after the recent bounce back to $36.

Disclosure: I am/we are long AAL.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities. Before buying or selling any stock you should do your own research and reach your own conclusion or consult a financial advisor. Investing includes risks, including loss of principal.