Despite the plunge in crude oil prices, many airline stock have not rallied as hard as some investors expected. The primary reason why airlines didn’t go up with the fall in crude is that investors expected oil stocks to rebound when it dipped under $40.
Stocks like American Airlines (AAL, Financial) are still struggling to breakout despite oil being over 50% cheaper than it was almost two years ago. Currently, American Airlines is trading at just 3x trailing earnings, however, the fundamentals don’t matter anymore.
Why fundamentals don’t matter
American Airlines may appear cheap, but the stock will continue to be range-bound and may struggle with oil prices moving higher. Investors are currently pricing in a recovery in crude oil prices in the stock. In a declining unit revenue environment and crude oil moving higher, American Airlines’ earnings are expected to take a hit in the coming quarters.
With oil moving higher and unit revenue falling, American Airlines P/E, which currently stands at 3, could balloon to double-digits in no time. Due to investors already pricing in the eroding fundamentals of the future, the downside of American Airlines is limited right now.
However, the stock will still struggle to break out and is not a compelling buy. American Airlines is competing on price against ultra-low cost carriers like Spirit Airlines (SAVE, Financial). I do not agree with CEO Doug Parker’s decision of competing against ULCCs on price, and I don’t think his vision is right to take American Airlines forward.
American Airlines' debt has grown considerably under his leadership, whereas the company has used all the money from oil saving to compete on price or buyback its shares that have already lost considerable value since the company sanctioned the buyback.
All in all, American Airlines has wasted most of the oil savings, and with oil prices slowly edging higher, the carrier will likely struggle.
Conclusion
American Airlines may appear cheap, but the stock is currently perfectly priced. Due to the reasons mentioned above, American Airlines will struggle to break out despite its cheap valuation. Since investors have already priced in the future concern into the current stock valuation, I think the downside is pretty limited. Hence, I am currently neutral on the stock. I reckon investors should wait on the sidelines.
