Buying Opportunity Arises for American Airlines

American Airlines (NASDAQ:AAL) may take a good deal longer than originally thought to turn around. This already seems clear in the recent movements in AAL stock. But I believe this could be an opportunity to buy the stock on the cheap.

Turbulence Ahead for AAL Stock as Cash Preservation Rules
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After reaching a recent high of $20.31 on June 8, the stock has been sliding ever since.

Even though AAL stock is up 25% from its closing low on May 13, it is now down about 56% from the June 8 recent high. In other words, investors have become much less sanguine about the company’s prospects going forward.

But, to contrarians like me, this provides a good buying opportunity for a company that is likely to survive and eventually thrive.

American Airlines Poor Q2 Results

Barron’s magazine took note of the drop in AAL stock. They noted that this was “likely the worst quarter in modern aviation history.” They wrote that American Airlines posted $1.6 billion in revenue, better than the $1.4 billion expected.

However, excluding special financing items, its adjusted net income was a loss of $3.4 billion. This works out to $7.82 per share. Barron’s said that was slightly better than an expected $7.84 per share loss, but I doubt the market cared.

The good news is that the company now claims it will have $16.2 billion in liquidity in the third quarter. This includes more borrowing, slowing cash burn and hopefully better revenue.

For example, the company said that its daily cash burn is now down to $30 million per day in June. That works out to $900 million or so per month and $2.73 billion per quarter.

On the one hand, that was better than the average of $55 million per day in Q2.  But, on the other hand, there is a ticking clock on how long the company’s cash can last.

You can calculate that its $16.2 billion in liquidity will last almost 6 quarters, assuming the cash burn does not slow down. American Airlines said in its earnings conference call that it expects Q3 cash burn to improve over Q2, and the same for Q4. It said it expects to be cash-flow positive in 2021.

The Wall Street Journal recently reported that airlines can reduce their costs more than expected. The article implied that the longer airplanes stay parked, the less it costs to maintain them.

What Analysts Say About AAL Stock

Barron’s reported that J.P. Morgan analyst Jamie Baker did a sum-of-the-parts (SOTP) analysis of AAL stock. He says it is worth $70 billion, but its $40 billion in debt lowers its value to $30 billion.

By my reckoning that is a fantastic valuation and represents a huge upside for AAL stock. For example, as of July 23, American Airlines had 508.561 million shares outstanding. So, the AAL market capitalization is now about $5.79 billion.

Put another way, the J.P. Morgan analyst implied that the inherent SOTP value of AAL stock is about $59 per share. This is over five times the present stock price.

Barron’s also reported that UBS rated American Airlines a “sell.” Their analyst believes that the stock will hit $9 per share, which is close to its previous recent lows. The analyst said the airline has “no more room to go on costs.”

What to Do With AAL Stock

It is very important to average cost into this stock if you are going to buy it. That is what I am doing with my investment in AAL stock.

The reason is the best time to buy is when everyone is negative on a company. That is how contrarians think. The issue, though, is that you have to see periods when the stock price falls after you invest in it. As long as you believe in its underlying value, it makes sense to buy more of a company at cheaper prices.

The basic belief that a vaccine will help turn around travelers’ willingness to fly on airlines is why AAL stock will likely rebound. Now it may take up to two years from now before the company’s prospects turn around.

But given that the market tends to discount the future, the stock price could easily rebound before then. In the meantime, cheaper prices in AAL stock are essentially a buying opportunity well below its SOTP value for patient, long-term investors.

Mark Hake runs the Total Yield Value Guide, which you can review here. As of this writing, Mark Hake, CFA holds a position in American Airlines (AAL).

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