12 BARRON’S September 30, 2019
WorriesoverthegroundedMAXjet,labortroubles,and
morehammeredtheshares,butsomeinvestorsarebetting
thattheworstisover. ByAlRoot
AmericanAirlines
StockLandsin
TheBargainBin
N
OTHING SEEMS TO BE GOING
right for American Airlines
Group this year. Boeing
grounded the 737 MAX, taking 24 of
American’s 956 mainline jets out of
service. Negotiations with the union
representing American’s mechanics
have yielded bitterness. Customers
are cranky, with the airline near the
bottom of the rankings on lost lug-
gage and on-time arrivals. Just this
past week, The Wall Street Journal
published an account of passengers
stranded in Peru for three days as
an 18-year-old plane suffered multi-
ple mechanical problems.
The troubles have hammered the
company’s shares (ticker: AAL),
which, like those of other airlines,
face fears over recession. Some in-
vestors are betting that this is about
as bad as it gets. If the Boeing (BA)
737 MAX can return to service and a
contract is reached with the mechan-
ics union, the reasoning goes, the
shares could be ready for takeoff.
American fetches just five times
estimated 2020 earnings of $5.50 a
share. Its stock is the worst per-
forming major airline over the past
year, dropping 33%, far worse than
the 3% average drop of airline peers
over the same span. The rest of the
group isn’t exactly soaring: U.S. car-
riers trade for less than eight times
estimated 2020 earnings, a 60% dis-
count to other consumer-discretion-
ary stocks in the S&P 500 index.
“At this valuation level, we believe
investors are more than compen-
sated for lower margins and a risk-
ier balance sheet,” wrote Jamie
Baker, a J.P. Morgan analyst, in a
recent research report. He rates
American shares an Overweight,
with a $40 price target.
Baker has a novel way of finding
a bargain: the “down 30 in 30 rule.”
The longtime analyst says that when
an airline stock loses 30% of its
value in 30 days, as American did
from July 24 to Aug. 27, it’s a sign of
investor capitulation—and quite pos-
sibly the bottom.
The Fort Worth, Texas–based
airline admits to some misses: “
should have been much better for
American,” Robert Isom, the air-
line’s president, said at a September
investor conference. The labor dis-
pute hurt operations, and the 737
MAX grounding increased costs,
preventing American from pursuing
“fleet harmonization,” or flying
fewer plane types to lower operating
costs by simplifying pilot training
and maintenance.
The MAX has been grounded
since mid-March after two fatal
crashes involving Boeing’s newest
single-aisle jet. The result: Aero-
space suppliers aren’t getting paid
for parts, and some airlines are fac-
ing hundreds of millions of dollars in
lost business, even as others cash in.
“The non-MAX carriers have bene-
fited from MAX carriers having
planes on the ground,” American
Chief Financial Officer Derek Kerr
says in an interview.
American canceled 7,800 flights in
the second quarter because of the
grounding, costing the company
about $175 million in pretax earn-
ings. For all of 2019, American esti-
mates that a lack of MAX capacity
will cost the company about $
million, about 10% of total operating
profit expected for this year. Boeing
targets the fourth quarter of 2019
for re-entry to service. That would
remove one of the headwinds for
American’s stock.
On the labor front,American won
a permanent injunction against the
International Association of Machin-
ists and Aerospace Workers in Au-
gust, barring mechanics from work
slowdowns to influence negotiations.
Mechanics want less maintenance
work outsourced. The airline wants
more flexibility. The union and the
company now go back to the negoti-
ating table with assistance from the
National Mediation Board.
“Eventually, [the labor dispute]
has to be resolved,” says Cowen ana-
lyst Helane Becker. “The mechanics
won’t work forever without a con-
tract.”
Of course, resolving the labor
dispute could mean higher costs.
And a MAX reintroduction could
mean higher capacity for the U.S.
industry, putting pressure on fares.
“We expect cost pressures to mount
in 2020 with the flight-attendant and
pilot contracts becoming amendable,”
or up for negotiations, in December
and January, writes Bank of America
Merrill Lynch analyst Andrew Di-
dora in a recent research report. He
downgraded American shares to
Neutral because of the labor issues
as well as slowing economic growth.
Kerr, American’s CFO, doesn’t
think the labor negotiations have
long-term implications for the airline
or its competitors. “Everybody is in
the same boat,” he says, regarding
Delta
Southwest
United
American
2017 ’18 ’
-
0
50
AAL
LUV
DAL
UAL
100%
Stock Performance Margin Change Since 2016 2019 On-Time Performance
Sources: FactSet; Bloomberg; Barron’s calculations; Bureau of Transportation StatisticsUnited
Southwest
Delta
American
-24%
-25%
-27%
-54%
84%
78%
76%
74%
Nowhere to Go But Up?
Shares and profit margins of American Airlines have trailed rivals over the past three years
while some measures of customer satisfaction have also lagged behind.
By The
Numbers
Shares of
American
Airlines look
inexpensive
compared to
those of some
rival carriers.
AAL
Ticker
2020 P/E Ratio
2020 Peers
P/E Ratio
$12 B
Market Cap
-15%
YTD Change
1.5%
Dividend Yield
Dave Murray