Now Is the Time to Pick Up American Airlines Stock
2021 is going to be a better year than 2020. That’s particularly good news for American Airlines (NASDAQ:AAL). After all, 2020 was an unsurprisingly ugly year for AAL stock. The novel coronavirus pandemic shut down the airline industry worldwide.
In the second quarter, American’s revenue declined 86% year-over-year. On an adjusted basis, American lost $3.4 billion in three months — after earning $800 million during the same period the year before.
Of course, 2020 wasn’t just ugly for the airline’s business. It was a difficult year in many ways. As a society, however, we’re finally turning the corner on a return to normalcy. Few companies will get a bigger boost than major airlines like American.
A Better Year Ahead
There’s no need to belabor the point of what an awful year 2020 was. But 2021 is going to be better.
The rollout of a Covid-19 vaccine should help the U.S., and the world, finally get the coronavirus under control. Domestic and global economies are recovering. No doubt many are disappointed in the outcome of the U.S. elections, but hopefully the political temperature in this country should come down substantially over the next few months.
I’m not dismissing the toll 2020 took, nor pretending that normalcy is just a few weeks away. There’s still plenty of work left to do. But we are heading in the right direction, if more slowly and more fitfully than some might hope.
Back to Normal
And a small beneficiary of that normalcy should be American Airlines. After all, it’s not as if 2020 highlighted something fundamentally wrong with the company’s business or its management. Flights were shut down. Business travel came to a halt, and recreational travel fell even further.
But the industry is recovering. American itself is offering preflight Covid-19 testing on some routes and should add to that program going forward. Expanded distribution of vaccines will further boost traveler confidence.
In fact, there’s going to be a significant amount of pent-up demand in the near term. Many consumers, particularly those who managed to avoid losing their jobs, have boosted their savings and no doubt are looking to travel as soon as it’s safe to do so. This is an industry that can make a lot of money in a hurry when travelers are flush and capacity is low. Both conditions are likely to be met in 2021 and 2022.
Bear in mind that before the pandemic, this was a business that was operating quite well. Pretax income (excluding special items) for full-year 2019 was $2.3 billion. Profit margins expanded nicely that year.
Indeed, the industry as a whole had rationalized capacity and largely stepped away from destructive price wars. AAL, simply put, was doing the right thing.
The pandemic brought all that to an end. But as the pandemic ends, the company will have a chance to regain its footing — and its profitability.
AAL Stock Is Cheap Enough
And in that outcome, AAL stock remains too cheap. Before the pandemic, American expected earnings of between $4 and $6 per share. It guided for free cash flow in 2020 and 2021 combined of some $6 billion.
AAL stock at the moment trades just above $15. Its market capitalization is $9.2 billion.
Even if American gets back halfway to where it expected to be in 2020 and 2021, the stock will look awfully cheap. That back-of-the-envelope model suggests earnings per share (EPS) in the range of $2 to $3. Free cash flow should be around $1.5 billion (given the projection for roughly $3 billion annually pre-pandemic).
So we’re looking at a stock trading at potentially 5x to 7x earnings and free cash flow. Airline stocks obviously don’t trade like tech stocks, but even in that context those multiples are dirt cheap.
Certainly, the rebound isn’t going to arrive immediately. 2021 is going to see lingering impacts of the pandemic. American had to borrow money to get through 2020, and that debt will add interest expense and suck up free cash flow.
But investors need to take the long view. That’s the argument I made in March, and it’s the same argument I’ll make now. Buying an attractive business at a single-digit multiple to earnings and cash flow is a good move, even if that multiple is a year or two out.
In the meantime, we’re in a market that to many investors looks expensive. There aren’t a lot of “cheap” stocks out there. There aren’t a lot of “return to normalcy” plays left that haven’t neared or surpassed pre-pandemic highs.
AAL stock checks both boxes. I expect investors will figure that out soon enough, meaning the stock will take off before its profits do.
On the date of publication, neither Matt McCall nor the InvestorPlace Research Staff member primarily responsible for this article held (either directly or indirectly) any positions in the securities mentioned in the article.
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