Amercian Airlines analysis: is the largest airline a good choice after the pandemic?

After lowcost Southwest Airlines and giant Delta Airlines comes American Airlines, which boasts the largest market share. What's more, it is at a significant discount to its competitors. What is the reason for this?

Amercian Airlines $AAL is one of the largest airlines in the world. AAL made a loss in 2020 due to the impact of COVID-19, but has otherwise posted long-term profits. Before the crisis, revenue, operating results and free cash from operations were growing. Revenue growth was around 5% per year. Operating margins were close to 10% in recent years. It is a stable giant, but growth prospects have been limited by competition and the obvious impact of the pandemic.

It is one of the so-called Big Three, along with Delta Air Line $DAL and United Airlines. They operate under the main American Airlines brand and other subsidiaries such as American Eagle and Envoy Air. They operate a long-haul network between the US and Europe, the Middle East, Asia and Latin America.

They operate to more than 230 locations in 53 countries and territories. It has approximately 130,000 employees, including 43,000 seasonal employees.

American Airlines' competitive advantages lie in its size, its dense network of connections and its modern fleet. Key strategies include investments in fast onboard internet connections and a lounge for premium customers. The company is also upgrading its fleet, strengthening partnerships and seeking to reduce operating costs.

Sector

The airline industry, which includes American Airlines, is a highly cyclical sector that is heavily dependent on the global economy and travel levels.

The COVID-19 pandemic has had a catastrophic impact on the airline industry, including a decline in passenger miles and revenue of more than 60-90%. The impact on revenue and profit growth is expected to be felt by airlines well into 2021. Restoring confidence in travel will be key to recovery.

Airlines are the largest in terms of market share. Source

The airline sector has strong competition, including among the largest airlines such as American Airlines, Delta Air Lines, United Airlines, Southwest Airlines and JetBlue Airways. As a result, ticket prices are often under pressure, which limits profit margins. Demand for air travel is strongly linked to economic growth, employment and personal income. Aviation fuel prices also form a significant part of airlines' costs, so rising oil prices increase operating costs.

The sector is undergoing a digital transformation, including investment in automation, tighter integration with other transport modes and personalised passenger experiences. These new technologies will require significant investment, increasing financial risk.

Despite its challenges, the air transport sector is likely to continue to grow, as will global trade and mobility. The air transport sector remains a cyclical sector that offers both opportunities and risks, depending on the global economy and oil prices.

Competition

Delta Air Lines $DAL is the second largest airline in the U.S. and is headquartered in Atlanta. DAL has a similar size and coverage area to AAL. DAL performed better than AAL during the COVID-19 crisis due to its stronger financial position. DAL is also more focused on premium travel.

United Airlines $UAL is the third largest airline in the US and is headquartered in Chicago. UAL has an extensive global network with hubs in Hong Kong, London and Amsterdam. UAL was hit hard by the COVID-19 crisis and had to undertake significant restructuring to survive. However, it is recovering operations faster than AAL.

Southwest Airlines $LUV is the largest low-cost airline in the US, headquartered in Dallas. LUV offers low-cost flights throughout the US. LUV is less reliant on international and business travel and was less affected by the COVID-19 crisis. Low-cost models are likely to gain market share more quickly after the pandemic.

- JetBlue Airways $JBLU is a regionalized airline based in Boston. JBLU focuses on travel on the east coast of the US and the Caribbean. JBLU was hit hard by the COVID-19 pandemic but managed to preserve liquidity due to its strong financial position. Once travel recovers, JBLU could gain market share but will continue to face strong competition.

Current situation

Unfortunately, AAL's results are not that dazzling. During one of the best bull markets, I would have really expected their sales to take off in 2014-2018, but it didn't happen.

The drop in profits due to the pandemic is clear. But it wasn't a miracle before that either. Source

Earnings per share have also flattened out over the past decade. As we have seen again, it is extremely difficult for airlines to keep costs in check. Covid-19 was a double whammy for airlines as revenues fell, but when it comes to airline operations, it is difficult to rein in costs so quickly.

All this has been well reflected in the share price. Its yields over the past decade are -30% and its maximum fall was at the height of the pandemic when many airlines could have been threatened with bankruptcy.

The company's last five years have not exactly been dazzling

American Airlines stock has negative equity, which means it owes more than it has. The pandemic has really taken a toll on them, and although we see a recovery in 2022 2023, it still has a long way to go to dig itself out of this financial hole.

Looking closer, things weren't so great before either. Also, in 2018, their equity went into negative territory. Back then, its CEO said it had its most challenging quarter ever.

But that may not be a bad thing. The bottom line is that the legacy airline has a lot of debt, which is partly due to buying a lot of planes before Covid. American Airlines has already met half of its goal of reducing its overall debt level by $15 billion by the end of 2025.

Although that number is unlikely to repeat next year, analysts project the airline will earn only $1.56 in 2023, with the Q4 estimate at a meager $0.30. The more revenue American Airlines earns now, the more cash flow the airline will generate to pay down debt to reduce interest costs and boost profits in the future.

On the one hand, analysts expect positive results. On the other hand, some don't really believe the company. Source

Net interest expense peaked at nearly $500 million per quarter back in mid-2021. American Airlines only spent $423 million on net interest expense in Q4'22, while interest income climbed to $110 million.

The airline can still save half of that interest expense by simply bringing quarterly costs back to pre-Covid levels of more than $200 million. With 715 million diluted shares currently outstanding, just the increase in interest expense will impact earnings per share by more than $1 per year.

The airline will use the vast majority of its free cash flow over the next few years to pay down significant amounts of debt. Once American Airlines reduces debt, the company will increase net income by reducing interest expense. As debt levels decrease, management will likely have more confidence to pay down even more debt from reducing excess cash balances.

American Airlines is not in a good situation, but assuming they can really turn this situation around, they could have potential. If only for the reason that $AAL is currently significantly cheap compared to the market average.

Disclaimer: This is in no way an investment recommendation. This is purely my summary and analysis based on data from the internet and other sources. Investing in the financial markets is risky and everyone should invest based on their own decisions. I am just an amateur sharing my opinions.