Can The US Airways-American Merger Make You Money?

| About: American Airlines (AAL)

by Larry Gellar

An interesting new development appears to be increasing the probability of a merger between US Airways Group (LCC) and American Airlines, a subsidiary of AMR Corp. (AAMRQ.PK). US Airways has secured the support of seven of American Airlines' labor groups as the company has formulated a plan that would keep more of the workers' jobs should the two airlines merge, as opposed to what would happen if American Airlines simply declares bankruptcy. In fact, the airline workers would also receive improved medical and severance benefits under a US Airways takeover.

While American Airlines is planning on revising its original proposal into a best and final offer, I would be very surprised if the labor groups prefer that over the US Airways plan. After all, US Airways has even promised to put holds on outsourcing, furloughs, and other labor disruptions. With that in mind, I would consider a US Airways takeover to be somewhat likely, and this would certainly boost the company's stock. Even without a takeover, though, I'm seeing a number of trends that make US Airways a valuable stock right now.

Besides American Airlines, other airlines that US Airways competes with include Delta Air Lines (NYSE:DAL), Alaska Air Group (NYSE:ALK), and United Continental (NYSE:UAL). US Airways has a lower price-to-sales ratio (0.12) than all of those names and a lower price-to-earnings ratio of (8.25), with the exception of Delta Air Lines. Part of the reason for those cheap ratios is certainly due to US Airways' relatively poor margins, but I'm not particularly concerned. For the record, those margins are 0.54% net profit, 14.42% gross, 5.24% EBITD, and 3.26% operating. One more interesting statistic is American Airlines' whopping price-to-book ratio of 10.59, but I'm not worried about that since book value can be thrown off by accounting procedures.

It's amazing to me that American Airlines has not been more embracing of a merger with US Airways, seeing as there appear to be a number of synergies the two companies would enjoy together. American Airlines' stance has been that it would prefer to go through the bankruptcy proceedings before making any decisions, but this could simply be a ploy to extract the best deal out of US Airways. Regardless, the financial benefits are remarkable -- at least according to US Airways President Scott Kirby. In fact, Kirby has described the merger as adding $1.2 billion of value beyond what employees would gain. Those savings would come from the elimination of certain facilities as well as management headcount reduction.

Considering US Airways just posted a solid earnings report, I'm inclined to side with its judgment. US Airways technically lost money when one-time items are excluded, but that loss was lower than analysts were expecting and it came on better-than-expected revenue as well. Moreover, with the one-time items net income was $48 million, so that's certainly exciting. Specific trends also look good for US Airways. Per-seat passenger revenue increased by 8.2%, and passenger traffic increased by 4.7%. These metrics are crucial for gauging how an airline will perform in future quarters, and Chairman and CEO Doug Parker even had this to say: "As we prepare for the busy summer travel period, we continue to be encouraged with the overall strength in passenger demand." In fact, the only truly concerning statistic was the 17% increase in fuel expenses, and I admit this could put a damper on future profits.

On the other hand, US Airways' Kirby was asked some tough questions at the earnings Q&A, and I certainly recommend potential investors check out his answers. For instance, he was asked about some fare increases that haven't worked out for US Airways, but he delivered a solid response. While it is true that fare increases don't always turn out great, US Airways has had better success with ridding itself of the most ridiculous marketing offers. For instance, the company is working to reduce the need to create big fare sales that ruin margins, as well as time-sensitive deals that can hurt the company's ability to adjust for demand.

I'm also impressed with Chairman and CEO Doug Parker's response to a question about hedging fuel costs. As mentioned above, fuel expenses for the company increased by 17%, so this was an important issue to address. However, Parker explained that it's simply not worth the cost to hedge fuel, and that there are already some natural hedges in place for the industry. For instance, if US Airways did hedge fuel, it could end up paying higher-than-normal prices when fuel prices fall -- and that would be even worse if that fall in fuel price was due to a poor economy. In other words, to the extent that fuel prices are tied to the strength of the economy, higher fuel prices are OK assuming they correlate with a stronger economy, which brings in additional revenue.

I believe US Airways had a solid quarter in terms of cash flow as well. Operating cash inflow was $417 million, and that led to a net change in cash of $243 million. $115 million flowed out for retirement of debt and $87 million flowed out for capital expenditures, and both of these outflows should help the company reach its goals. It is worth noting that US Airways, along with most other airlines, don't pay dividends, so those hunting for additional income may wish to look at other industries. For those who can take all their returns in the form of price appreciation, though, US Airways appears to be on the right track. A merger with American Airlines would help this company enormously, but even without that, I like the way this airline is run.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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