American Airlines Is FinishedAAL) for several months and the stock has dropped over 25% since I first recommended selling it. Although I recently said the stock may have bottomed in a recent article, American Airlines has continued heading lower and I think it will likely continue struggling with a recovery in crude oil prices.
Oil prices have jumped almost 100% since hitting the multi-year lows earlier this year. While there’s still a long way to go before oil reaches the 2014 highs of over $110 per barrel, rising costs are a negative for American Airlines.
Don’t be fooled by the valuation
American Airlines is trading at a P/E ratio of just 2.87 and is trading close to its 52-week lows.
My thesis has proven to be correct as American Airlines has continued plunging despite its apparently cheap valuation. Airlines investors are very skeptical about price wars and are more obsessed with profits than they are with unit revenue. Since many airlines have gone bankrupt fighting of price amid a cheap fuel environment, investors nowadays do not focus as much on the short-term profits that carriers generate from cheaper fuels than they do on the unit revenue.
Since investors know that fuel will not stay cheap forever and that profits that the carriers are enjoying is only short-term, they tend to punish airline stocks when they indulge in price wars. Clearly, the market wants airlines to put the money saved from cheaper fuel to better use.
American Airlines has failed to use the money wisely and has instead used it to undercut ULCCs like Spirit Airlines, buyback shares and improve its fleet. American Airlines has not focused on reducing its towering debt and has instead taken on more debt to fund the buybacks.
As a result, shares of the company have followed a downward trajectory and will likely continue to do so. In addition, American Airlines may appear cheap, but rising oil prices will erode its profits and due to tough year over year comparisons, the carrier’s profits will fall, which in turn will increase its P/E ratio. The market has clearly priced in the concern of a crude rally, and the long-term upside of American Airlines is pretty limited unless the company changes its approach.
Published on Jun 2, 2016By Akshansh Gandhi