Shares of American Airlines (NASDAQ: AAL) plunged to a new 52-week low last week as rising trade tensions and fears of a global economic slowdown roiled the stock market.
Its Friday closing price of $27.23 was less than six times American Airlines’ projected 2019 earnings. Other than a brief period of panic in mid-2016 following the U.K.’s vote in favor of Brexit, American Airlines stock hadn’t fallen below $30 since shortly after its late-2013 merger with US Airways.
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To be sure, American Airlines faces serious threats, including stubbornly high costs; massive debt, pension, and lease liabilities; and continuing labor unrest. Nevertheless, investors may be underestimating the ability of the world’s largest airline to bounce back from its current challenges.
Global economic turmoil: Bad for American, worse for its rivals
Slowing economic growth and rising tariffs threaten the profits of global businesses. Lower profits could, in turn, encourage companies to save money by cutting back on discretionary business travel. The weakening of international trade relationships could have a particularly large impact on long-haul international travel. All of this explains why investors have sent the shares of global airlines like American Airlines lower recently.
That said, American Airlines has a smaller footprint in China — and Asia more broadly — than its two main rivals, particularly after the cutbacks it implemented last year. Furthermore, American gets 73% of its passenger revenue from the domestic market, compared to 71% for Delta Air Lines and about 62% for United Continental. Thus, an extended trade war with China might not hurt American Airlines as much as its competitors.
Meanwhile, trade tensions and fears of an economic slowdown have sent oil prices tumbling. Crude prices have fallen by more than $10 per barrel since late April — with most of that drop coming in the last two weeks — following sharp increases in the first several months of 2019.
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A $650 million increase in the carrier’s full-year fuel cost estimate was one big factor driving American Airlines’ April guidance cut. (The company reduced its EPS forecast from a $5.50 to $7.50 range to a $4 to $6 range at that time.) Yet jet fuel prices are now slightly lower than when it made its initial forecast in late January. That could offset some deterioration in the revenue environment.
Of course, there’s no guarantee that fuel cost savings will outweigh the impact of a slowdown on unit revenue. However, the U.S. economy still seems quite strong, which should limit the near-term risk of a big drop in unit revenue, whereas the fuel cost savings are already flowing through to American Airlines’ bottom line.
A big profit-growth catalyst is about to kick in
Another reason why American Airlines stock could recover is that the carrier’s biggest revenue-growth initiative in recent years just started to ramp up. This spring, it began to add a slew of new routes at Dallas-Fort Worth International Airport (DFW) — its largest hub, and also one of its most profitable. It’s also increasing its flight frequency on many existing routes.
In total, American expects to grow its DFW service from 810 peak-day departures in 2018 to around 910 peak-day departures this summer. The recent opening of 15 new regional jet gates at the airport has paved the way for this growth. Management believes that driving more traffic through its largest hub and enabling more connections there will unlock significant unit revenue and margin growth. The new routes are already off to a good start, and performance should improve beginning this summer as the routes mature.
Ongoing terminal expansions in Charlotte and Washington, D.C., will allow American to grow its operations in its other two highest-margin hubs in 2020 and 2021. And DFW is beginning to design a new terminal that would add up to 24 new gates as early as 2025, enabling further growth there.
The combination of expansion and lower fuel prices will likely drive an acceleration in American Airlines’ earnings growth beginning next quarter. On the flip side, the carrier has ample room to shore up profitability by eliminating low-margin routes from its smaller hubs in the event of a broader economic slowdown.
Additionally, the carrier plans to reduce capex dramatically over the next three years. This will free up cash so it can start paying down debt. The company still faces plenty of risks, but American Airlines stock already trades at a massive discount to the market. If its earnings growth accelerates as expected, the stock price could quickly take flight.
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Adam Levine-Weinberg owns shares of Delta Air Lines and is long January 2020 $20 calls on American Airlines Group. The Motley Fool owns shares of and recommends Delta Air Lines. The Motley Fool has a disclosure policy.
