American Airlines' Big Secret

| About: American Airlines (AAL)
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Summary

The company managed to double its operating cash flow since 2014 and most people think this is due to the acquisition in 2014.

I show that this new cash flow was actually based on luck i.e. the unexpected oil crash.

American Airlines' operating cash flow are too depended on oil prices and thus fragile.

This is not a growth stock.

American Airlines (NASDAQ:AAL) operates a network of carriers. In other words, it transports people through air through the use of planes. While the oil industry suffered from the steep decline in oil prices, companies such as AAL profited.


Source: author's excel sheet and numbers are from the most recent 10-k

While the Company was struggling to generate cash from its operations in the years 2012 and 2013, 2014 and beyond proved to be very lucrative. It is strange for such a big company to suddenly double its operating cash flows. This is because big companies are usually bogged down by their own size and other elements like regulation. Another way one could explain this sudden enormous boost in operating cash flow is an acquisition. If we take a look at the balance sheet, it becomes clear that a sizable acquisition was made. The company added about $4 billion assets and $2 billion in intangibles in 2014. Especially the goodwill increase is a telltale sign of an acquisition. The total acquisition price was about $11 billion and the new combined company generated $42 in revenue. The operating cash flow, however, came in at 'just' $3 billion in 2014.

Now, let's take a look at the cost of revenue and the gross margin:

Source: author's excel sheet and numbers are from the most recent 10-k

The decline in oil prices has clearly influenced the cost of revenue as they have been declining. Even though the cost of revenue in 2013 and 2016 are roughly the same, the company was close to twice as big in 2016 as it was in 2013. The gross margin highlights the oil price tailwind even clearer:

Source: author's excel sheet and numbers are from the most recent 10-k

The gross margin clearly spikes after 2014, the same period in which oil started its decline. The company ends up generating more than $6 billion in operating cash flow in 2015 and 2016. This is roughly a doubling of the 2014 level. Almost all of this was as a result of lower oil price.

As alluded to in the introduction, the company did not hedge:

10-k regarding 2014
"During the second quarter of 2014, we sold our portfolio of fuel hedging contracts that were scheduled to settle on or after June 30, 2014. We have not entered into any transactions to hedge our fuel consumption since December 9, 2013 and, accordingly, as of December 31, 2014, we did not have any fuel hedging contracts outstanding. As such, and assuming we do not enter into any future transactions to hedge our fuel consumption, we will continue to be fully exposed to fluctuations in fuel prices. Our current policy is not to enter into transactions to hedge our fuel consumption, although we review that policy from time to time based on market conditions and other factors."

10-k regarding 2015
"As of December 31, 2015, we did not have any fuel hedging contracts outstanding to hedge our fuel consumption. As such, and assuming we do not enter into any future transactions to hedge our fuel consumption, we will continue to be fully exposed to fluctuations in fuel prices. Our current policy is not to enter into transactions to hedge our fuel consumption, although we review that policy from time to time based on market conditions and other factors"

Note the final sentence: "Our current policy is not to enter into transactions to hedge our fuel consumption." Management is obviously counting their blessings here.

And just to be safe, here's 2016's quote from the 10-k:
"As of December 31, 2016, we did not have any fuel hedging contracts outstanding to hedge our fuel consumption. As such, and assuming we do not enter into any future transactions to hedge our fuel consumption, we will continue to be fully exposed to fluctuations in fuel prices. Our current policy is not to enter into transactions to hedge our fuel consumption, although we review that policy from time to time based on market conditions and other factors."

The fact that the company does not plan to hedge its oil price in the near term, is actually quite interesting. Many companies in the oil industry are actually beginning to have a cautiously optimistic outlook on the oil price. So what are these oil executives saying?

"Ingredients are there for a recovery to a sustained $60 price environment for next year." - Anadarko Petroleum's Chief Executive Al Walke

And there are more according to this article: "Other large US independents, such as Marathon Oil and Occidental Petroleum, offered more reserved price forecasts of around $50 in the next year or so.

"We do expect it to be $50 or above in 2017, but certainly we're not as bullish as some people," Oxy CEO Vicki Hollub said. "We're taking … a conservative view, but it would be fundamentally above $50″ (OD Aug.4'16).

Marathon CEO Lee Tillman told analysts earlier this month that at prices in the low to mid-$50s, the Houston-based independent could grow production while still spending within cash flows in 2017.
Further evidence that supports this theory are the company's net margin.

Source: author's excel sheet and numbers are from the most recent 10-k

While AAL is still laughing to the bank, the oil industry is emerging from a cyclical downturn. Perhaps it's time for management to prepare for higher oil prices. It would have been wise to deleverage while the low oil prices are boosting their profits. Realistically speaking, there is still time for this. However, the company doesn't seem to be in any hurry to clean up their balance sheet, since they actually increased the leverage by adding an additional $4.2 billion of debt in 2016 on top of the $18.3 billion debt load in 2015.

While some investors might consider AAL to be a cheap growth play, the company is actually just an inverse oil play speculation. The reason some investors might consider this to be a cheap growth play is because the PE currently stands at 9, suggesting mid to high single digit growth. The actually growth forecast are actually around 18%, which would give the illusion of buying cheap growth. Investors who fall for these types of trap would do well to look at the PEG ratio, which looks at the PE relative to the growth and a peg ratio of 4 would suggest that the growth here is definitely not cheap growth. Now that oil is regaining ground, AAL's cash flow should normalize and subsequently reduce the value of the stock.

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

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.