Previously in this series, we looked at American Airlines Group’s (AAL) 3Q15 earnings report and how the airline managed to achieve its highest-ever historical net profit, grow its capacity, and improve its capacity utilization.
Now let’s see how these factors have affected its valuation multiple and where its peers are trading.
Airlines are capital-intensive with high levels of depreciation and amortization. They also have varying degrees of debt and operating leases.
To neutralize these factors, we use the EV/EBITDA (enterprise value to earnings before interest, tax, depreciation, and amortization) ratio for valuing airline stocks. The forward EV/EBITDA ratio shows what investors are willing to pay for the next four quarters of estimated EBITDA.
American Airlines’ forward EV/EBITDA multiple
Following its 3Q15 earnings release, American Airlines remained flat. As a result, its valuation multiple also hasn’t changed much.
- American Airlines is currently trading at a forward EV/EBITDA multiple of 4.7x, which is close to its average valuation of 4.6x. This indicates that analysts may be estimating higher growth in the next four quarters.
- American Airlines traded at an all-time high multiple of 6x in June 2014 and a low of 2.8 in January 2014.
- Among the company’s peers, Southwest Airlines (LUV) enjoys the highest forward EV/EBITDA multiple of 5.6x, Alaska Air Group (ALK) is trading at 5.5x, JetBlue Airways (JBLU) is trading at 5.4x, and Spirit Airlines (SAVE) has a multiple of 5.29x.
- Delta Air Lines (DAL) is currently trading at 4.7x, and United Continental (UAL) is trading at 4.12x.
Following American Airlines’ 3Q15 earnings release, analysts’ consensus 4Q15 sales estimate remains almost unchanged at $9,785 million, while the consensus earnings per share (or EPS) estimate has risen by 3% to $1.89. For 2015, analysts estimate that sales will fall by 4% to $41.6 billion, while EPS is expected to rise by ~58% to $8.99.
This growth in profitability is expected to slow going forward. In fact, for 2016, analysts are expecting EPS to fall by 30% to $6.29 on 1.2% sales growth. For 2017, sales are expected to grow by 4% and EPS by 8% to $6.80.
Falling crude oil prices since the start of 2014 are one of the major reasons for improved profitability across all airlines. Capacity growth aided by increasing air travel demand also boosted growth. However, capacity growth has been exceeding industry demand, and investors have started fearing overcapacity in the industry.
As oil prices are expected to recover toward the end of 2016, airline profits should also normalize to pre-2014 levels. Also, American Airlines’ recent announcement that it will lower fares may cause price wars in an attempt to capture market share. This will result in falling profitability for all airlines, including American.
In this way, American Airlines Group’s upside could remain limited. The company forms 5% of the holdings of the Dynamic Leisure & Entertainment ETF (PEJ).