If you happen to be one of those visionary investors in American Airlines Group Inc (AAL) this year, give yourself a well-deserved pat on the back.
After all, AAL stock has been on a tear since the merger of US Airways and the then-bankrupt American Airlines was finalized a year ago this week. Although the early stages of integrating the two airlines have gone smoothly and AAL shares have gained more than 90% this year, CEO Doug Parker’s toughest challenges might still be ahead.
Parker, whose grand strategy delivered what likely is the last U.S. airline mega-merger, deserves a couple of victory laps. His charm offensive secured the support of the legacy carrier’s unions and creditors, enabling Parker to acquire American Airlines out of bankruptcy and form what is now the world’s largest carrier. Since then, AAL’s market value has doubled to $34.8 billion.
But the big question for investors now is whether or not AAL stock can keep soaring in 2015. Here are three pros and three cons:
AAL Stock Pros
Bigger Can Be Better. The American Airlines-US Airways merger created a powerhouse competitor in the commercial airline sector — AAL boasts 6,700 flights a day to 56 countries worldwide. Consumer demand remains strong and consumers appear willing to pay higher fares — a positive factor for AAL earnings and revenues going into 2015. Economies of scale in the wake of the merger likely will help AAL take good care of its shareholders — AAL approved up to $1 billion in share repurchases; earlier this year the carrier paid out its first dividend since 1980.
Improving the ‘Product’. Low fuel prices are freeing up a lot of cash that AAL can use to improve the “product” — Parker this week announced plans to spend $2 billion on upgrades to its fleet, lounges and clubs. Improvements include more than 100 new aircraft by the end of this year, fully reclinable seats in first class, and in-flight upgrades like Wi-Fi and power ports.
Low Fuel Prices. Plummeting oil prices have been driving the airline sector higher — not a surprise, given the fact that fuel accounts for as much as one-third of carriers’ operating costs. Jet fuel prices are expected to slump into the $2.20 a gallon range — the lowest price in more than four years. American, which spent more than $8 billion on jet fuel in the first nine months of this year, is poised for a big boost in earnings.
AAL Stock Cons
Labor Challenges. Greg Parker’s charm offensive toward the then bankrupt airline’s unions was a critical component for getting the deal done. But honeymoons are seldom long-lived — particularly in major airline marriages. But few observers expected the combined airline’s 24,000 flight attendants to vote down a five-year contract that guaranteed pay raises, but not profit sharing. Perhaps most contentious: the contract was voted down by a 16-vote margin. Arbitration sessions after the vote took just two days and the outcome will be released in January. Regardless of how that turns out, the union members are deeply divided — and that promises to create some level of turbulence next year as AAL works to integrate its labor contracts.
System Integration. Parker’s experience with the merger of US Airways and America West in 2005 illustrates the importance of details. Integration challenges run the gamut, from culture wars and labor challenges to systems glitches while combining flight schedules and reservations systems. AAL plans to migrate all of its employee and reservations data to American’s system in the second half of 2015. This is a tough challenge that historically has resulted in computer crashes and short-term disruptions in operations.
Tough Industry to Make Money. As Warren Buffett once quipped: “If a farsighted capitalist had been present at Kitty Hawk, he would have done his successors a huge favor by shooting Orville down.” Despite the monster gains in airline stocks this year, it’s important to temper that optimism with the fact that airlines are a tough business if you’re trying to make money. Airlines face high fixed costs, narrow margins and fierce competition. They also are among the most cyclical of consumer stocks — and wild cards like Ebola, regulations or bad economic news can hit these stocks hard. Consider that the entire airline sector slumped on Tuesday after a disappointing profit outlook for low-cost carrier Spirit Airlines Incorporated (SAVE).
Bottom Line
AAL stock has more than doubled year to date and the merger is firing on all thrusters. The valuation is cheap with a price to earnings growth (PEG) ratio of 0.24 and forward price-to-earnings ratio of under 7. But while I believe AAL has what it takes to go the distance, now is not the best time to initiate a new position in the stock.
As of this writing, Susan J. Aluise did not hold a position in any of the aforementioned securities.
