AAL might be a big value - but it looks more like a big value trap

January 22, 2019

AAL might be a big value – but it looks more like a big value trap

Yesterday, I wrote about news over the weekend that winter storms had resulted in more than 1,100 cancelled flights out of Chicago. Another report indicated that from the Midwest to New England, total cancelled flights were more than 2,000 over the course of the weekend. The market was closed yesterday, so the first opportunity the market is going to have to react to this news is today. Don’t be surprised, however if airline stocks in particular are among the most volatile in the market through the entire week.

Every major carrier seems to be scrambling to find way way to accommodate or compensate travelers who have been affected by these widespread cancellations. Cancellation fees are being waived, and in many cases customers can change their tickets to fly later int he week without paying any additional fees. Southwest Airlines (LUV) reported that travelers with tickets to destinations affected by storms can fly up to two weeks later without paying any difference in price.

Yesterday I spotlighted Delta Air Lines (DAL) as a stock with an interesting value proposition – if you’re willing to accept the likelihood right now of increased volatility in the near term that could drive the stock even lower. One of DAL’s biggest competitors, American Airlines Group (AAL) is down even more than DAL’s 21% decline. AAL hit its most recent high in March of last year at almost $58 per share before beginning an extended downward trend that is well into its tenth month. The stock’s total decline is almost 41%. The question, of course is not dissimilar from what you should be asking about working with a stock like DAL. Are the company’s fundamentals strong enough to make the stock look like a nice bargain at its significantly depressed price, or is the fact that the stock is in a downward trend that has lasted nearly a year a sign of deeper troubles that equate to higher risk? Let’s take a look.

Fundamental and Value Profile

American Airlines Group Inc. is a holding company. The Company’s primary business activity is the operation of a network air carrier, providing scheduled air transportation for passengers and cargo. The Company operates through American segment, which provides air transportation for passengers and cargo. The Company’s cargo division provides a range of freight and mail services with facilities and interline connections available across the globe. Together with its regional airline subsidiaries and third-party regional carriers operating as American Eagle, its airline operated an average of nearly 6,700 flights per day to nearly 350 destinations in more than 50 countries, principally from its hubs in Charlotte, Chicago, Dallas/Fort Worth, Los Angeles, Miami, New York, Philadelphia, Phoenix and Washington, District of Columbia, as of December 31, 2016. In the fiscal year ended December 31, 2016, approximately 199 million passengers boarded its mainline and regional flights. AAL’s current market cap is $15.6 billion.

  • Earnings and Sales Growth: Over the last twelve months, earnings declined by about 20.5%, while revenues increased by a little more than 6%. In the last quarter, earnings declined almost -31%, while sales were mostly flat, but also negative by -.72%. The company operates with a very narrow margin profile, with Net Income running at 2.6% of Revenues for the last twelve months as well as the last quarter.
  • Free Cash Flow: AAL’s free cash flow is negligible, at only than $73 million. That translates to a Free Cash Flow Yield of a mere .46%. This is a significant red flag, and is a dramatic downturn from the beginning of 2017, when Free Cash Flow was more than $900 million.
  • Debt to Equity: AAL is among the most highly leveraged companies in its industry. The debt/equity ratio in this case is not practical as a measurement, and so instead we’ll focus simply on the fact that while the company’s balance sheet indicates that operating profits are adequate for now to service their debt, liquidity is a question. The company had cash and liquid assets of $5 billion in the last quarter against more than $22 billion in long-term debt.
  • Dividend: AAL pays an annual dividend of $.40 per share, which translates to a dividend yield of about 1.17% at the stock’s current price.
  • Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value. That’s hard for AAL, since the stock doesn’t actually have a Book Value right now. The only useful valuation metric we can work off of is the stock’s Price/Cash Flow ratio, which is currently 25% below its historical average. If you’re willing to overlook the absence of an actual Book Value (I’m not), that offers a long-term target price a little above $42 per share.

Technical Profile

Here’s a look at the stock’s latest technical chart.

  • Current Price Action/Trends and Pivots: AAL’s decline from its March 2018 high is easy to see. The stock is about 18% above its lowest point right now. The stock’s price pattern over the last month looks like it could be building a consolidation base right now; however the stock would need to break above its early December peak at $40 before you can really start calling for any kind of sustainable bullish trend. If the stock breaks below its latest support in the $29 area, it should test previous pivots from mid-2016 at around $25 next.
  • Near-term Keys: Given the fundamental concerns related to this stock – poor Free Cash Flow, high debt, narrow operating margins, and the absence of a useful Book Value, it’s hard to think about AAL as any kind of a bargain or value stock right now, even with the stock’s big decline over the past year. If you want to be very aggressive, you could think about buying call options, or using the stock outright for a bullish swing trade right now with an eye on the December high between $39 and $40 as a near-term price target; but I think the odds are much more in favor of seeing the stock hover in a narrow sideways pattern right now, which really favors neither a bullish nor bearish trade. A break below $29 should be taken as a signal to short the stock or buy put options, with a price target in that case at around $25 per share.