American Airlines: Debt and Cost Growth Limit Resurgent Opportunity; Cutting Fair Value Estimate

We have taken a fresh look at the North American airlines and instituted an industry-based demand model for air travel, capacity, and revenue. As a result, we have lowered our fair value estimate for no-moat American Airlines AAL to $12.20 per share from $21.

We have tempered our view of the medium-term operating environment for U.S. airlines to include a return to normalized competitive dynamics after current supply constraints moderate, likely in a year or two. In many ways, we forecast 2023-27 as resembling the 2015-19 period before the pandemic, with declining fuel costs, a mostly consolidated industry, and robust demand for air travel. But three key differences temper this outlook: The industry piled on billions of dollars of debt to withstand the pandemic, the current period of high profitability will have erased tax shields that the airlines all enjoyed in the previous era, and postpandemic labor agreements will add structural costs to airlines’ income statements. Although American Airlines may have the dubious distinction of enjoying its tax loss shields longer than peers, its leverage also constrains our valuation.

Our 2027 midcycle forecasts for American include an $0.18 revenue passenger mile yield, a 23% share of a growing pool of revenue passenger miles, and load factors in the mid-80s. They also incorporate nearly $0.02 per available seat mile of additional structural costs that appeared between 2015 and 2019, the so-called honeymoon prepandemic period for airlines. We do maintain the $0.033 spread between American’s passenger revenue and nonfuel recurring costs per mile, which allows for moderate operating margin expansion over the next several years.

We reaffirm our view that there are no durable competitive advantages to be had in this industry, and that long-term investors should seek exposure to air travel elsewhere, such as with the wide-moat suppliers of airframes and jet engines, whose products airlines compete with one another to buy years in advance.