Airline stocks have been killed as the outbreak of the coronavirus from China has gone global over the past few weeks, with most airline stocks dropping more than 25% from their mid-February highs. Among the biggest losers in the group has been American Airlines (NYSE:AAL), largely because of the company’s huge debt burden and its sizable international flight exposure. From its mid-February highs, AAL stock has shed a whopping 50%.
You read that right. American Airlines stock has been cut in half in a matter of weeks on coronavirus concerns.
Buying airline stocks may seem like an extremely risky, maybe even bone-headed move, in the current environment. After all, who is flying these days? But you have to understand that these stocks are priced for the apocalypse. Before the outbreak, the earnings per share of American Airlines was supposed to be about $5 in 2020. Even if the coronavirus knocks its earnings down by 20%, its EPS this year will still be about $4.
AAL stock is changing hands for $15 per share. That means the stock is trading at less than four times analysts’ average 2020 earnings estimate. That’s an apocalypse-type multiple.
But the apocalypse isn’t going to happen. Instead, coronavirus hysteria will fade in the next few weeks as the virus’ spread slows. In April or May, the coronavirus outbreak in the U.S. — and across the globe — will largely be in the rear-view mirror. Demand for airplane tickets will come surging back because most consumers won’t give up flying because of an outbreak that only lasts for two months.
As demand for airplane tickets rebound, American Airlines stock will mount a huge comeback.
Coronavirus Fears Will Pass
I want to make two things abundantly clear.
First, the coronavirus crisis is a big, scary, and volatile thing. It should not be taken lightly. Second, nothing in the data tells me that it’s time to panic or even worry. In fact, the data tells me that the outbreak will pass soon and won’t inflict much damage along the way.
The virus hit China and South Korea first. A few weeks ago, each country was reporting thousands of new cases each day. Then, each country implemented strict quarantining, and the virus stopped spreading. Now the outbreak in each country is largely over, with China reporting just 26 new cases on Mar. 10 and South Korea reporting just 35 new cases on the same day.
Assuming the U.S. and other countries follow similar patterns, the base-case scenario is that the virus will largely be in the rearview mirror by April or May.
Meanwhile, only one in 10,000 people got the virus in South Korea. Only one in 20,000 people got it in China. The reported mortality rate is above 3%, but the actual mortality rate is considered to be less than 1%, given unreported case, and well below 0.5% for anyone not over the age of 50 and/or with a preexisting medical condition.
Even further, in about three months, the virus has killed about 4,000 people globally. Cancer kills that many people every four hours.
All in all, then, the hysteria over coronavirus is a temporary thing. In April or May, it will fade. By June or July, consumers will be back to normal, virus-free and with lots of pent up demand.
American Airlines Will Bounce
There is no denying the fact that airline travel will be negatively impacted as long as consumers suffer from coronavirus hysteria and as long as governments and institutions restrict travel.
American Airlines is not immune to this slowdown. About 73% of the company’s flights are domestic. Those flights will be hurt by U.S. business travel restrictions and consumers second guessing their spring vacation plans. Meanwhile, demand for American Airlines’ international flights will get hurt even more, thanks to travel restrictions.
But this slowdown will not be permanent.
By April, the hysteria over coronavirus will cool down. Some businesses will lift travel restrictions and some consumers will start to fly again. By May or June, the coronavirus outbreak will be in the rear-view mirror. Some businesses will resume traveling at full capacity, and some consumers will go on their big summer vacations.
By 2021, no one will talking about coronavirus. All consumers and businesses will get back to their regular globe-trotting routines.
AAL stock is down 50% on challenges that will last a few months and then disappear. In 2021, I fully expect this company to earn at least $4.50 per share.
Historically, the normal forward price-earnings multiple for this stock is seven. A P/E multiple of seven and a projected 2021 EPS of $4.50 implies a 2020 price target for the stock of over $30.
The Bottom Line on AAL Stock
American Airlines stock has been beaten up on coronavirus concerns, and rightfully so. Nobody is traveling these days.
But this selloff has gone too far. At its current levels, AAL stock is too cheap, considering the problems caused by coronavirus are fleeting and that air travel demand will pick back up in a few quarters.
I think the shares can stage a huge rally into the end of 2020 on easing coronavirus hysteria and improving air travel demand.
Luke Lango is a Markets Analyst for InvestorPlace. He has been professionally analyzing stocks for several years, previously working at various hedge funds and currently running his own investment fund in San Diego. A Caltech graduate, Luke has consistently been recognized as one of the world’s top stock pickers by various other analysts and platforms, and has developed a reputation for leveraging his technology background to identify growth stocks that deliver outstanding returns. Luke is also the founder of Fantastic, a social discovery company backed by an LA-based internet venture firm. As of this writing, Luke Lango did not hold a position in any of the aforementioned securities.