September 30, 2019 BARRON’S 13
pay levels at four major carriers. “It’s
almost pattern bargaining now. There
won’t be a labor-cost advantage.”
Bullish investors argue that American
has a chance to improve its operations
relative to its peers. Since 2016, Ameri-
can’s profit margins have fallen about
50%. Margins for the rest of the industry
are down about half that amount. Ameri-
can also trails its peers in on-time perfor-
mance by about five percentage points.
Management is targeting $1billion in
profit improvements versus current lev-
els. If that goal is accomplished, margins
would move back in line with peers.
If operations normalize and the MAX
returns, American shares could reach $37,
up from their recent level around $27. At
that point, American stock would trade
for just 6.7 times Wall Street’s estimated
2020 earnings, still a discount to peers
such as Delta Air Lines (DAL) and
Southwest Airlines (LUV).
Further gains could be ahead as man-
agement pays down its hefty debt. Over
the next 12 months, American is targeting
$1 billion in debt reduction, or about 8%
of the company’s market capitalization.
“We are done with our aircraft-
replacement program, and capital spending
is going down for the next few years,” Kerr
says, adding that the lower debt trend will
continue. American also buys back shares
and pays a dividend, with a recent yield of
about 1.5%. Shares outstanding have fallen
16% over the past three years.
If airlinesmanage to make money
through a downturn, the sector could
earn a higher valuation multiple from
investors. Profits in a recession are far
from guaranteed, but they are far more
likely than in the past. After mergers
following the financial crisis, the four
largest U.S. air carriers, including their
regionals, have about an 80% market
share. And the current generation of air-
line executives is focused more on profits
than capacity growth.
The new industry structure and disci-
pline are evident in airline financials.
American is expected to generate operat-
ing margins of about 8% in 2020. That’s
down from 13% in 2016, but 8% would
have been a profit-margin record in the
14 years before American’s 2013 merger
with US Airways.
Investors typically shy away from eco-
nomically sensitive stocks near the end of
a long economic expansion, fearing that a
good value can become a value trap. But
American’s shares are especially cheap,
and potential relief is in sight. Value in-
vestor Warren Buffett is along for the
flight. His Berkshire Hathaway (BRKA)
owns nearly 10% of American stock.
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