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American Airlines Stock Rose 5.6% Last Week

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American Airlines (AAL) stock rose 5.6% last week. There was continued momentum in American Airlines shares. On August 28, JPMorgan Chase (JPM) made positive remarks about the company.

Dip in American Airlines stock is a buying opportunity

According to the Dallas Business Journal, JPMorgan Chase analyst Jamie Baker sees the current dip in American Airlines stock a buying opportunity. Baker compared the company’s situation with the “pre-merger Continental Airlines and post-merger United Airlines” circumstances. Before the merger in 2010, both of the companies’ stocks witnessed a sharp decline. However, United Airlines stock rebounded after the merger, according to the Dallas Business Journal report.

In a note to clients, Baker said, “The market has consistently been proven mistaken when delivering this level of shellacking.” He also said, “Those brave enough to step in have consistently been rewarded.”

The analyst has set a target price $40 on American Airlines stock, which signals a return of 44% from the closing price of $27.79 on September 6. The analysts polled by Reuters provided a consensus “buy” recommendation on the stock. The average target price of $38.53 reflects an upside potential of 38.7% over the next year.

Stock has an attractive valuation

American Airlines stock has lost nearly 13.5% of its market value YTD (year-to-date). The stock has underperformed the broader market as well. The NASDAQ, the S&P 500, and the Dow Jones indexes have risen 22.1%, 18.8%, and 14.9%, respectively, YTD. The stock has also underperformed the iShares Transportation Average ETF (IYT), which has risen 12.6% YTD. IYT invests in Dow Jones transportation stocks. Approximately 20% of IYT’s portfolio includes passenger airline stocks.

Currently, the stock is trading near its five-year low of $24.85 reached on June 27, 2016. American Airlines stock has fallen 53% from its five-year high of $59.08 attained on January 16, 2018. The stock has fallen nearly 36.7% from its 52-week high of $43.89 reached on September 21, 2018.

The YTD decline in American Airlines stock has made it attractive on the valuation front. The stock has a forward one-year PE ratio of 5.7x, which is much lower than the industry average of 7.8x. The stock also trades at a significantly discounted valuation multiple compared to its top three peers. Southwest Airlines (LUV), United Airlines, and Delta Air Lines (DAL) have one-year forward PE ratios of 12.3x, 7.3x, and 8.2x, respectively.

MAX crisis hurt American Airlines stock the most

So far, American Airlines stock had a rough ride this year, especially after its second-quarter earnings results. The stock has lost 12.3% of its market value since its second-quarter earnings results on July 25. The company’s shares fell more than 8% on July 26 after it disclosed that the second-quarter results took a massive hit from Boeing’s (BA) grounded 737 MAX aircraft.

Notably, Boeing’s 737 MAX planes have faced a global flying ban since mid-March following the Ethiopian Airlines crash on March 10. American Airlines, which owns 24 MAX aircraft, suffered approximately 7,800 flight cancelations in the second quarter due to the grounding. The global flying ban on MAX jets reduced American Airlines’ overall capacity by 0.8% in the second quarter. The company revealed that the flight cancelations had a negative impact on its second-quarter pre-tax income by $175 million.

American Airlines expects the MAX trouble to hurt its fiscal earnings more than previous projections. During the second-quarter earnings results, the company raised the fiscal estimate for costs related to flight cancelations to $400 million from $350 million.

Apart from American Airlines, Southwest Airlines and United Airlines also own Boeing’s 737 MAX planes. Southwest and United have 34 and 14 MAX jets, respectively. Southwest has registered over 20,000 flight cancelations since the MAX grounding in mid-March. United Airlines canceled 3,440 flights in the second quarter due to the flying ban on MAX aircraft.

Investment opinion

We think that American Airlines is making successful arrangements to lower its flight cancelations due to the MAX grounding. According to data compiled by airline analytics firm OAG, American Airlines’ flight cancelation rate improved in August, which is positive for the company. According to the report, the company canceled 2.7% of its total flights in August—lower than 3.2% canceled in July. We could see a lower-than-expected negative impact from the MAX grounding in upcoming quarters.

American Airlines has other concerns too. For the past few months, the company faced business disruptions due to an ongoing labor contract dispute with its mechanics. The conflict impacts American Airlines’ regular business operations.

In May, the airline blamed its mechanics for purposely slowing down maintenance work to obtain the upper hand in contract negotiations. Between June 14 and August 13, American Airlines faced nearly 950 flight cancelations, according to a CNBC report on August 14.

Last week, American Airlines filed a criminal complaint against one of its mechanics for sabotaging a plane with 150 people on board, according to a Reuters report on September 6. The mechanic, Abdul-Majeed Marouf Ahmed Alani, admitted during the investigation that he was upset with the negotiations between the company and the mechanic union. The contract negotiations had a negative impact on him financially.

The labor contract negotiation seems to be turning bitter. We think that the delay in finalizing the contract might cause more business disruptions for American Airlines. Since the mechanic union has rigid demands, American Airlines might have to make peace with the union by paying hefty pay packages like Southwest Airlines did in May.

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