Indicators of operating performance and valuation
American Airlines (AAL) has successfully managed to emerge from bankruptcy and regain the confidence of investors by providing returns beyond expectation. Even after the merger there have been no hiccups in the airlines’ operations. Also, on-time arrivals have improved to 80% in May, 2014. Among the legacy carriers, American Airlines ranks second with an American Customer Satisfaction Index (or ACSI) score of 66. There’s scope for further improvement as the overall score for airlines was 69 and its strongest competitor, Delta (DAL), scored 71.
The operating metrics, as seen in the previous table, also show that AAL is posing strong competition to its peers. It has the second highest passenger revenue per available seat mile (or PRASM) calculated as the product of revenue passenger miles (or RPM) and yield divided by the available seat mile (or ASM). AAL already has the highest RPM and capacity measured by ASM. With an improvement in the capacity utilization measure by load factor—currently lower than peers at 80%—it should be able to further improve PRASM. This is combined with the lowest cost per available seat mile (CASM) among the legacy carriers. However, the company has a high leverage of 94% after the merger which is compensated to a certain extent by a strong liquidity position—highest among its peers.
Looking at its valuation multiples AAL seems to be undervalued as its pricing-earnings (or P/E) ratio is lowest compared to its peers. Also, a forward earnings before interest, taxes, depreciation, and amortization (or EBITDA) multiple of 14%, which is in line with the peer average, looks good for a forward enterprise value (or EV)/EBITDA of 5.4x. Among its legacy peers, DAL also is a fundamentally strong company with the highest forward EBITDA margin among its peers and lower leverage, but United (UAL) with the lowest EBITDA margin of 9.9% isn’t a comparable investment. Although its low cost competitors, Jet Blue (JBLU) and Southwest (LUV), have a forward EBITDA margin comparable to AAL’s, their P/E ratios are high—14.5x and 11.9x—compared to AAL’s 6.3x which means investors have to pay higher price for each dollar of earnings. If AAL maintains the same rate of growth as reported in the first quarter, its operations continue to gain efficiency, and it’s able to reduce leverage, its valuation would make AAL shares an investment worth considering.