Increasing Our Fair Value on American Airlines
New revenue opportunities that were quantified at the firm's latest investor day drove the $3 per share boost.
American Airlines (AAL) held an investor day at which management implored investors to take “The Leap of Faith” with them, meaning that we should believe U.S. airlines have renounced the days of overcapacity, irrational pricing, and bankruptcies. We’ve leaped halfway. We think U.S. airline operating margins will fluctuate between the high single digits in a recession and the high teens during boom times. But we still don’t believe U.S. airlines possess a moat, given a business model that is not conducive to rational pricing, a lack of entry barriers, air travel commoditization, and the presence of low switching costs coupled with price transparency. We are raising our fair value estimate for American to $49 per share from $46, owing primarily to new revenue opportunities that were quantified at the investor day.
American believes it can drive $2.9 billion in additional revenue (about 1.5% of our total 2017-21 forecast revenue) through 2021. Basic and premium economy are the largest opportunities at $1 billion, and co-branded credit cards provide another $550 million; both were already quantified. However, American also quantified other initiatives that should generate another $1.35 billion. On the cost side, American sees a $1 billion opportunity thanks to its One Airline project, which further integrates US Airways. Management cited flight attendant harmonization, a reduction in subfleets, and maintenance integration as important steps.
American reiterated a $5 billion pretax income target, noting that consensus sits at $3.6 billion and $3.9 billion for 2017 and 2018, respectively. Management also discussed an adjusted (excluding fuel, special items, and any contract changes) unit cost growth target of 2% in 2018 and 1%-2% in 2019 and 2020. Taking into account revenue and cost efforts, we are modeling pretax income averaging $4.4 billion from 2017 to 2021, and normalized pretax income is set at $5.5 billion, representing a 11.5% margin.
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Chris Higgins does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.