Low costs have contributed to the upside of many airline stocks. My favorite pick in the sector is American Airlines (AAL, Financial) as the company has enjoyed the most benefit from cheaper oil prices due to its no hedging policy.
Despite the substantial earnings potential, shares of American Airlines are trading lower this year due to the concerns regarding its debt and on-going price wars with low-cost airlines. With the stock now trading at just 3.6x trailing earnings, I think its downside potential is pretty limited and long-term investors should use the current dip as a buying opportunity.
Substantial savings
Due to the heavy plunge in oil prices in the previous year, most of the major airlines saw a huge profit jump and will gain more advantage from the further drop this year. American Airlines benefited the most from the plunge due to its no hedging policy and with fuel prices expected to stay low, I think American Airlines is nicely positioned to benefit from it.
As of now, jet fuel prices are hovering around $1.00 gallon due to which the company is seeing savings of approximately $1.80 per gallon. As per American’s previous annual report, the company projected its yearly fuel intake at 4.3 billion gallons. This number coupled with the per gallon difference consequence in a likely yearly savings of $7.7 billion.
As compared to $40 per barrel oil, $30 per barrel oil signifies a huge savings as it further lowers jet fuel price around 20 cents per gallon. Keeping in mind the 630 million shares, this turns into a yearly savings of approximately $860 million or $1.37 per share. In spite of huge fuel savings, American Airlines has focused its consideration on PRASM and probably will remain doing so until the metric become stable or turns around.
Leading position in Los Angeles
American Airlines is the biggest airline company in Los Angeles and it seems prepared to continue this lead in the approaching quarters. Most recently, the company launched its flights from Los Angeles to Sydney, Australia, and is on its way to launch flights from Los Angeles to Auckland, New Zealand this summer.
Los Angeles is very valuable market for every airline company, and in current years none of the U.S. airline have been able to grasp a leading position in the market. If the company somehow manages to grasp a solid leading position in Los Angeles, it should see huge rewards in the upcoming years. The high value industries, extent of the metro area, and huge population gives American Airlines lots of prospective to increase its flights frequency to serve most markets in the world.
Conclusion
Given the drop in oil prices, I think investors are underestimating American Airlines’ earnings growth potential. American Airlines is trading at an extremely cheap valuation and the stock will not be held back due to its debt concerns for the long-term. As a result, I think American Airlines is a great buy.
