American Airlines (NASDAQ:AAL) will likely make substantially more cash flow by the end of 2021. As a result, AAL stock could be worth at least 53% more than today based on its historical cash flow margins.
The airline said on Oct. 22 that it expects to significantly reduce its daily cash burn in Q4 to about $2.6 billion. This is based on a fall in its liquidity from $15.6 billion to $13 billion by the end of the quarter.
The airline also said it expects system capacity to be down 50% or so during the quarter. But the good news is that it will have sufficient capacity to last through 2021. Assuming traffic picks up, its cash flow should be significantly higher by the end of the year.
The latest TSA security checkpoint numbers show that traffic is starting to rise. For example, for the week ending Nov. 28, the total number of travelers was 40% of the total last year. During several of those days last week, traffic was up to 45%.
Moreover, with the arrival of several vaccines soon, traffic demand will likely pick up, despite lockdown restrictions mainly in the larger cities in the U.S. This will significantly push up its cash flow from operations (CFFO).
American Airlines’ CFFO Model
We can put together a simple model using a projection of American Airlines’ CFFO by the end of the year. Analysts polled by Seeking Alpha expect that revenue will be $27.21 billion in 2021.
We can use this forecast to estimate its CFFO by the end of 2021. For example, last year American Airlines made $3.885 billion on revenues of $45.768 billion. That works out to a CFFO margin of 8.5%.
Moreover, even when business turned down in Q1 due to the onslaught of the coronavirus, American Airlines still had positive CFFO. It generated $2 billion CFFO on $43.669 billion in revenue over its last 12 months (LTM) to March 31, 2020. That is still a margin of 4.6%.
So let’s assume that by 2021 year-end, the market will assume, due to increased traffic, that American Airlines will make an average margin of 6.5%.
Therefore, if it reaches revenue of $27.21 billion, its CFFO will be $1.769 billion. This may not be enough to lead to free cash flow profits, but I believe the market will assume those will arrive.
Now if AAL stock sports a 10% CFFO yield, its market capitalization will be worth $17.69 billion. That is over 100% higher than its present $8.2 billion market cap.
But let’s get even more conservative. Let’s say that American Airlines makes just a 4.6% CFFO margin, just like in the LTM March quarter. That implies a CFFO of $1.256 billion (i.e., 4.6% times $27.21 billion in revenue forecast for 2021).
Using the same 10% CFFO yield, the market cap will be $12.56 billion. That is 53% higher than the company’s present $8.2 billion market cap.
In other words, AAL stock is worth at least $22.92 per share, 53% higher than its price of $14.98 as of Nov. 27.
What to Do With AAL Stock
Granted, this is a simplistic way of looking at the potential value for American Airlines. Other analysts on the sell-side of Wall Street are not as sanguine about the company.
For example, TipRanks reports that nine analysts have an average price target of $10.20. That represents a 32% drop in AAL stock which is at $14.98, as of Nov. 27. Yahoo! Finance also reports a target of $10.92 for 18 analysts.
However, Marketbeat.com says that the consensus price target of 20 analysts is $14.50, or a downside of 3.2% from today.
I wouldn’t put too much faith in these analysts. It is much better to derive your own simple model, which you can easily track or verify, just like I did above.
That way you can have more conviction should you buy the stock at today’s price. Once the stock hits your target, you can reassess the situation using the same model in order to decide whether to sell.
My very conservative model shows AAL stock should rise by 53% by the end of 2021 to $22.92 using very conservative assumptions.
On the date of publication, Mark R. Hake had a long position in American Airlines stock (AAL).