The New American Airlines: 3 Pros, 3 Cons for AAL Stock

by Susan J. Aluise | April 22, 2014 6:00 am

The New American Airlines: 3 Pros, 3 Cons for AAL Stock

Little more than four months after the $11 billion mega-merger that created the new American Airlines (NYSE:AAL[1]), AAL stock is still soaring and most analysts are bullish on the combined airline’s future. That said, the hardest work — the mammoth challenge of integrating the airlines’ fleets, people and complex computer systems — is yet to come.

American Airlines 185 The New American Airlines: 3 Pros, 3 Cons for AAL Stock[2]Shareholders will get to see the combined carrier’s first report card on Thursday, when it reports earnings for the quarter ended in March — a quarter in which tens of thousands of weather-related cancellations are certain to impact not only earnings, but other key airline operating metrics as well.

But the biggest questions for investors now is whether AAL stock can continue to soar and whether it’s time for AAL to take a breather and for investors to take profits. If you’re thinking about boarding AAL now, here are three pros and three cons:

AAL Stock Pros

AAL Stock is on a Tear: Against all odds, American Airlines has repaid shareholders’ faith handsomely since the legacy carrier filed for bankruptcy protection in November 2011. At that time, the stock that traded under the now-defunct ticker “AAMRQ” was 26 cents per share. Since the merger, there have been five distributions to investors that held AAMRQ stock on Dec. 9, the day the merger closed. The total of those distributions (the last one was made on April 9) gave shareholders 0.74 shares of AAL stock[3] for every share of AAMRQ, according to the Dallas Morning News. That amounts to nearly $28 worth of AAL stock for shares of AAMRQ that last traded around $11 the day before the merger.

AAL Has a Cargo Hold Full of Cash: American Airlines does a pretty good job of amassing cash. Many Wall Street observers were surprised by American’s bankruptcy filing in November 2011 because the company was sitting on $4 billion in cash. After merging with US Airways and emerging from bankruptcy, the New American Airlines now has $9.25 billion in total cash. Compare that to traditional mainline carriers like Delta Air Lines’ (DAL[4]) $3.8 billion and United Airlines’ (UAL[5]) $1.4 billion, and it gives AAL stock a nice cushion — and the potential to institute a dividend down the road.

New American Makes Big Changes to Boost Profits: AAL has been making a lot of changes since the merger. Here are some of the most significant: The merged US Airways and American is rising on the OneWorld global code-share alliance, which includes global powerhouses like British Airways, Cathay Pacific, Iberia, Japan Air Lines and Qantas, giving the combined carrier a stronger global presence. AAL also is adding more flights to Asia and is positioning itself to cash in big on the business travel market.

AAL Stock Cons

The Toughest Challenges Are Still Ahead for AAL Stock: In airline mergers, honeymoons are short and marriages are hard. The New American Airlines has hit the ground running with its integration, but it still faces turbulence as it combines corporate cultures and merges technology systems. Integrating IT systems that range from reservations and check-in sites to aircraft maintenance and accounting systems will take years and cost millions of dollars. AAL stock should feel the pinch of these teething troubles for the rest of the year.

Old Man Winter Pounded First Quarter Earnings: Expect AAL stock to take a hit on Thursday when the full earnings impact of those 34,000 bad weather cancellations in the first quarter is revealed. Earlier this month, AAL warned that its first-quarter revenue could take a $115 million hit from Old Man Winter — and operating profit could be $60 million lower than expected. Of course, the sector’s heavy hitters also report this week and are likely to take a similar earnings hit from the winter storms. But AAL stock may take a bigger pounding because it has gained 44% since the deal closed on Dec. 9. Conversely, shares of mainline competitors DAL and UAL only have gained around 17% in that same time frame, making AAL stock more vulnerable to a retreat after earnings.

American Airlines Can’t Unilaterally Cut Retiree Benefits: AAL suffered a setback last week as a federal bankruptcy judge ruled the company could not unilaterally terminate health and other benefits for around 47,000 retirees. Judge Sean Lane, who presided over American’s bankruptcy, said the new American Airlines Group cannot shift more than $1 billion in annual health[6] and other benefits to retirees. The decision doesn’t hobble AAL’s ability to compete — during bankruptcy, unions agreed to cut $1 billion in labor costs — but the issue is far from resolved. The prospect of continued high benefits costs could weigh on AAL stock.

Bottom Line: The merged US Air-American is a force to be reckoned with, but honeymoons are notoriously short when it comes to airline mega-marriages. Although AAL’s valuation is cheaper than rival airline stocks with a forward P/E of just 6.3 and a puny  price to earnings growth (PEG) ratio of 0.19, I think the new AAL has flown as high as it can for now.

As of this writing, Susan J. Aluise did not hold a position in any of the aforementioned securities.

Endnotes:
  1. AAL: http://studio-5.financialcontent.com/investplace/quote?Symbol=AAL
  2. [Image]: http://investorplace.com/wp-content/uploads/2014/02/American-Airlines-185.jpg
  3. 0.74 shares of AAL stock: http://aviationblog.dallasnews.com/2014/04/aamrq-holders-to-get-another-0-1864-shares-of-aal-american-airlines-group.html/
  4. DAL: http://studio-5.financialcontent.com/investplace/quote?Symbol=DAL
  5. UAL: http://studio-5.financialcontent.com/investplace/quote?Symbol=UAL
  6. $1 billion in annual health: http://online.wsj.com/news/articles/SB10001424052702304626304579509813362429386

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