The rollout of the Covid-19 vaccine in the United States and worldwide is giving the airline industry hope. American Airlines Group (NASDAQ:AAL) stock outperformed the major indexes for the first two months of the year.
As the vaccine administration reaches the majority of the population, AAL stock will continue climbing.
Markets may ignore the weak results as the rebound potential from higher airline traffic boosts American Airlines.
Losses Will Not Cool AAL Stock
In the fourth quarter, American Airlines posted GAAP earnings per share loss of $3.81. Revenue plunged by 64.4% year-on-year to $4.03 billion. The $18.36 EPS loss should frighten investors away. Fortunately, the stock market is forward-looking and is pricing recovery in the industry. AAL has several positive developments.
The airline ended the fiscal year with around $14.3 billion in liquidity. This will top $15 billion in the first quarter of this year. This will equip the company with the financial flexibility to continue operating despite losing money.
Should the credit markets seize up, AAL will face no financial distress. In recent weeks, the U.S. Treasury yields rose sharply. This signals a tightening debt market and an eventual rate hike.
AAL raised more than $13 billion in 2020. After issuing debt at lower rates, the airline may focus on building the business post-Covid.
Cost actions will increase AAL’s efficiency. Chairman and Chief Executive Officer Doug Parker said that it may take out $1.3 billion in non-operating costs. Though forecasting for 2023 depends on future demand, the lower cost for operations will speed up its return to profitability.
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The CEO did not commit to any demand level forecasts in the next two years. Readers may apply the cost cut in a discounted cash flow EBITDA exit model. This uses an EBITDA exit multiple to calculate terminal value after five years.
MetricsRangeConclusion Discount rate 8% – 7% 7.5% Terminal EBITDA multiple 5x – 10x 8x Fair value $5.17 – $41.47 $26.26 Model from finbox
Investors may apply a generous 8x multiple and come up with a very wide fair value. In the most optimistic scenario, AAL posts a strong revenue rebound for the next four years. It may earn an EBITDA as a percentage of revenue in the mid-single digits.
Financial modelers may adjust for a higher earnings percentage after American implements cost-control measures. It will need passenger traffic growing sharply every year to justify a fair value of around $26.
As you can see in the chart, analysts are highly bearish on AAL. The stock has the most “strong sells” that outweigh the “buy” and “hold” calls.
Based on its future cash flow, simplywall.st forecasts a $44.34 fair value for AAL shares. Still, this bullish view is clouded by earnings losses. So, the site cannot tabulate a price-earnings or a P/E to growth ratio to compare its valuation to peers.
Chief Financial Officer Derek Kerr broke down the $1.3 billion in cost cuts in two buckets. It will save $500 million from cuts to management. Another $700 million in savings will come from other labor. Other items like facilities consolidations, benefits and fuel efficiencies will add positively to efficiency.
By adjusting for a lower flight volume scenario, American Airlines will survive. Conversely, should demand rise faster than expected in the next three years, AAL may quickly scale up operations.
Capital expenditure requirements over the next two years are minimal. Plus, the government loan will sustain AAL’s liquidity. It only needs to concern itself with the refinancing terms next.
AAL is priced to perfection, with more upside to go. Markets are hunting for growth plays and look at the airline as the next turnaround. The vaccine offers strong hope of a work-from-home and stay-at-home order ending everywhere.
When that happens, airline stocks will benefit quickly. After the rally, markets are betting on a bigger-than-expected recovery.
Disclosure: On the date of publication, Chris Lau did not have (either directly or indirectly) any positions in the securities mentioned in this article.
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