Airline stocks have sold off in the last few weeks, which is surprising since crude oil prices have been falling consistently and are now near multiyear lows.
Crude oil is down more than 70% in the last 18 months. On an average, fuel expenses accounted for about 33% of airlines’ earnings when oil was trading at more than $100 per barrel. However, due to the massive drop in crude prices, that number has fallen to under 20%.
Despite such a massive reduction in expenses, many stocks in the aviation industry have underperformed. I explained the reason for this phenomenon in my previous article. However, I expect the current earnings season to kick-start the recovery of airline stocks. American Airlines (AAL, Financial) is my favorite stock for the earnings season.
American Airlines ended 2015 in the red and has sold off considerably in 2016 as well. The massive fall seems surprising as American Airlines is the only carrier that doesn’t hedge fuel prices. This means that American is benefiting the most from cheaper crude, and the company has used the cash wisely to improve its fleet and expand capacity.
Despite the company’s “no hedge” policy, investors have punished the stock primarily because of the company’s ongoing price war with ultra low-cost carriers. However, the selloff is irrational as American Airlines is reporting record profits. Since crude oil prices have fallen consistently over the last few weeks, American Airlines should have an earnings report that will push the stock higher.
Valuation
American Airlines is trading at roughly 5x trailing earnings. Given the strong earnings growth and expansion, American Airlines is undervalued, and investors should consider the stock going into earnings. The ongoing price war will not affect American Airlines in the long run as crude prices have fallen a lot faster than air fares. For these reasons, investors should consider American Airlines going into earnings.
Conclusion
Given that crude oil is trading near multiyear lows, American Airlines will probably report record earnings in the coming quarter. The company’s “no hedge” policy has helped it benefit the most from the fall in crude, and it has used the cash smartly to improve its fleet. Despite the tailwinds, the stock has sold off considerably in the last few weeks. The earnings season will push American Airlines’ stock higher, and investors should buy the stock at least for the short term.
