Last week’s incredible 77% weekly gain in American Airlines (NASDAQ:AAL) unexpectedly rewarded those who bought AAL stock at the $8.25 – $10.00 bottom.
The bearish bet might explain the quick rebound, but if the short float of 35.3% drove last week’s rebound, what should investors expect to be happening next? Investors need to compare the speculation against other trades that went well. Investors should also weigh the passenger ban, fundamental risks and fair value.
“Back to $10 Robinhood traders have 0 idea what they buying. Balance [sic] sheet is upside down. Unencumbered assets worth far less than current price. The reason why Buffett fully exited lower. They don’t teach finance in the Sherwood Forest.”
A Closer Look at AAL Stock
Citron cannot be too quick in judging young or inexperienced traders. The markets priced the airline industry based on worsening unemployment and a slow re-opening of the economy.
Last Friday’s jobs numbers may have overblown the jobs increase because of low labor force participation of 60.8%. But markets bid airline stocks higher after realizing jobs are coming back sooner than thought.
The faster jobs return, the more likely consumers will start booking vacations, travel from one State to another by airplane, and will companies will authorize business trips.
Last Thursday, China eased coronavirus restrictions. It will allow for more foreign carriers. With the U.S. permitted to fly carriers once a week in the region, investors have less to worry about.
American Airlines spokesman Ross Feinstein said that the company still plans to “resume service to China at the end of October.” Lower infection rates are still the key driver to increased flight traffic to China.
For example, the Civil Aviation Administration of China (“CACC”) will allow more international flights based on the number of passengers testing positive for coronavirus.
Fundamental Risks and Fair Value
The incredible rally in American Airlines may settle and pull shares lower once investors look at the daily passenger traffic.
On May 31, passengers screened at TSA checkpoints stood at around 353,000. This is sharply below last year’s 2.56 million. So, the U.S. still has a high count of daily infections.
Worldwide, infections are elevated in Latin America and Russia. Investors still do not know if the riots, which drew large crowds, will lead to more infections in the U.S. in the next 10-14 days. Any sharp increase in infections will deter travelers from flying.
So far 14 analysts covering American Airlines have a $12.00 price target. Still, only two analysts updated their view on the stock. Both J.P. Morgan and Raymond James issued a “sell” rating within the last three days. Similarly, do-it-yourself investors may forecast an over 50% revenue drop this year followed by a rebound next year.
Based on the metrics below, American shares are worth nearly $20 a share on a conservative 10% discount rate:
|Discount Rate||11.0% – 9.0%||10.0%|
|Terminal Revenue Multiple||0.3x – 0.8x||0.4x|
|Fair Value||$0.83 – $60.99||$19.27|
|Upside||-95.5% – 228.1%||3.6%|
In the 5-year discounted cash flow revenue exit model, I assume capital expenditures falling to 2% of total revenue. Working capital falls on expectations of decreasing capacity requirements.
Notice the wide fair value output from this model. As investors get better passenger traffic growth data to work with, the fair value range will shrink.
The sharp rebound in American Airlines may have come to an end. Now that the speculators will book them quick, weekly gains, airline investors should wait for a better entry price before adding to their position.
Disclosure: As of this writing, the author did not hold a position in any of the aforementioned securities.