The Collapse of American Airlines Stock Has Created an Opportunity

There's reason to believe that AAL stock is gearing up for take-off

Shares of American Airlines (NYSE:AAL) have been under pressure ever since early 2018, as the airline has been hit by one headwind after the other. American Airlines stock dropped more than 50% from January 2018 to August 2019.

American Airlines (AAL) Stock: There's Opportunity In the Rubble
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First, rising oil prices hit the company’s margins hard in early 2018. Then, recession fears and slowing global demand hurt AAL stock in late 2018.

Early this year  – just as things were starting to get better for American Airlines – Boeing’(NYSE:BA) had massive problems with its MAX 737 plane. The subsequent grounding of those planes  created under-capacity issues for American Airlines which have weighed on its margins and profits.

The last 20 months have been ugly for AAL stock. But there’s reason to believe that American Airlines stock is now a good opportunity for investors.

The headwinds which have hit AAL stock hard over the past 20 months will inevitably fade. That will probably happen soon. Oil prices should fall for the foreseeable future, thanks to rising supply and falling demand. Demand for air travel will remain strong, thanks to healthy global labor conditions. The 737’s difficulties  will be solved, and those planes should start flying again by late 2019.

All in all, by the end of 2019, American Airlines could be benefiting from strong demand, low oil prices and full capacity. That will be a winning combination for American Airlines stock. Since those improvements aren’t priced into AAL stock today, American Airlines stock could be due for a big comeback rally between now and the end of the year.

Things Will Get Better for American Airlines

American Airlines stock has tumbled over the past 20 months because the outlook and optics surrounding the company have been consistently negative. Heading into the end of 2019, that should change tremendously.

Over the past 20 months, American Airlines has dealt with rising oil prices (which killed its margins in early 2018), slowing demand (which caused its revenue growth to decelerate in late 2018), and the grounding of the 737s (which pushed down its volumes and added cost pressure). Given that backdrop, it’s no wonder AAL stock has dropped over 50% since early 2018.

Over the next year, the outlook and optics of American Airlines will change for the better. Oil prices likely won’t rise meaningfully in the near-term. The oil market is being flooded with new supply. Oil supply outstripped oil demand by 900,000 barrels per day in the first half of 2019, according to IEA. At the same time, the global economy is heading into a manufacturing recession, according to many experts, and that will inevitably weigh on oil demand. Thus, going forward, oil prices should drift lower.

Meanwhile, demand for airplane travel  should remain robust. Younger consumers value experiences over products,  and traveling is one of their most coveted experiences, creating a strong, non-cyclical tailwind for American Airlines. At the same time, labor conditions globally are very good, featuring low unemployment rates and rising wages. That means consumers have both the appetite and ability to travel, implying that airline demand should remain healthy for the foreseeable future.

Last, but not least, the MAX 737  groundings are just temporary. These planes will get back up in the air within the next year. When they do, American Airlines’ capacity issues will be resolved, and air-traffic-volume growth will come back into the picture.

American Airlines Stock Hasn’t Priced in the Upcoming Improvement

Over the next year, American Airlines’ performance will improve dramatically. That will lead to a huge rally by AAL stock, mostly because the stock today doesn’t price in any improvement, let alone a dramatic improvement.

American Airlines stock trades at 5.6-times analysts’ average forward earnings estimate. That’s dirt-cheap. Historically, AAL stock has traded at a forward price-earnings multiple north of seven, and its forward P/E ratio has often been above eight. Meanwhile, the average forward P/E multiple across the entire airline industry today is indeed north of eight.

Thus, AAL stock trades at a dirt-cheap forward earnings multiple that is discounted both relative to its history and the valuation of the entire airline sector today. Clearly, no good news is priced into AAL stock at this point.

As good news does materialize over the next 12 months, then AAL stock will jump. Simple modeling (based on low-single-digit-percentage revenue growth, gradual margin expansion and some share buybacks) implies that American Airlines can realistically net earnings per share of about $7.50  by 2025. Based on a forward multiple of eight, that implies a 2024 price target for AAL stock of $60. Discounted back by 10% per year, that equates to a 2019 price target of about $37.

Thus, fundamentals indicate that within the next few months, AAL stock can surge 30%.

The Bottom Line on AAL Stock

American Airlines stock has been killed over the past twenty months, and the downturn was justified.

But there’s opportunity in the rubble of this collapse. Specifically, over the next 12 months, the fundamentals, outlook, and optics of AAL should all meaningfully improve. As they do, depressed AAL stock looks well-positioned to stage a big comeback rally.

I’m a buyer of American Airlines on weakness ahead of that  comeback rally. I think that AAL stock could exceed $35 within the next few months.

As of this writing, Luke Lango did not hold a position in any of the aforementioned securities, but may initiate a long position in AAL within the next 72 hours. 

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