As you can see in the graph below, immediately after American Airlines (AAL) merged with US Airways in December 2013, AAL was trading substantially below its peers. The reasons are obvious. It had just emerged from bankruptcy and merged with another airline. The success of the merger was still very uncertain.
AAL’s high leverage among its peers and low utilization and yields compared to its peers ensured that the valuation remained low for the next few quarters. However, as oil prices started falling in mid-2014, AAL’s no-fuel-hedging strategy paid off. This ensured its fuel cost was the lowest among the industry peers, increasing profitability multifold.
Valuation followed suit. Since mid-2014, American Airlines’ valuation has closely matched its industry peers, as you can see in the above graph.
You should keep watch on American Airlines’ expected future debt reduction, capacity expansion, and future margins. This is especially important since analysts believe that airline margins have peaked.
You should also keep an eye on the industry, since industry fundamentals also impact a company’s valuation multiple.
Airline industry fundamentals have seen tremendous improvements in the last two years. If industry fundamentals deteriorate or investor appetite for risk declines, valuation multiples can also fall. On the other hand, improving global travel and the economic outlook would be a huge positive. You can watch these signs by following our industry insights on our Airlines page.
Investors can gain exposure to airlines by investing in the PowerShares Dynamic Leisure & Entertainment ETF (PEJ). PEJ holds 5% in Southwest Airlines (LUV), 4.6% in Delta Air Lines (DAL), 4% in United Continental (UAL), and 4% in American Airlines (AAL).