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American Airlines Is Losing Lift

On Wednesday, Goldman Sachs (

GS, Financial) analyst Catherine O’Brien downgraded American Airlines (AAL, Financial) from neutral to sell, reducing the price target to $18 due to weaker sector recovery and higher fuel prices.

O’Brien isn’t alone in projecting a less than rosy outlook for the financially troubled airline. Wall Street sets a consensus rating of hold for American Airlines versus an overweight rating for Delta Air Lines (

DAL, Financial) and a buy rating for Southwest Airlines (LUV, Financial). United Airlines is even more out of favor with a consensus rating of underweight.

Costs rise as the recovery slows down

The economic recovery is taking longer than many initially expected as new and more contagious coronavirus variants keep showing up. Supply chain issues have proven more persistent than expected due to backup in demand, port closures, climate disasters and labor shortages.

A supply crunch is also hitting the energy sector, causing fuel prices to spike. Jet fuel is primarily derived from crude oil, which broke $80 per barrel for the first time in three years near the end of September. Rising fuel costs will make each flight more expensive, potentially causing airlines to cancel more flights

Financial troubles

Before the pandemic, the four major U.S. airlines were on a share buyback spree, indulging in high payouts to executives via stock option compensation plans and then buying back even more shares than were issued for this purpose in order to keep both executives and shareholders happy. They felt safe doing this despite being in steep debt because they believed nothing could halt the growth of the airline industry.

We all know what happened then; the pandemic struck, and American Airlines, which had the most debt out of all its competitors, faced the worst cash crunch. Its operating margin plummeted the most out of the four U.S. airline majors, and it is still the least profitable today:

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Some say that it might have been better for the company to restructure rather than getting handouts from the government. Out of all the airlines, American was the most likely to file for bankruptcy without government intervention, but it’s not like the company hasn’t gone bankrupt before. In fact, between 2002 and 2011, American, Delta and United all filed for Chapter 11, and they kept flying throughout, emerging stronger on the other side.

Regardless, American seems to have muddled through without going into bankruptcy this time, even though whether or not this has helped its financial situation depends on who you ask.

Adding to American’s troubles is the fact that it has largely built its moat around being the most available and affordable among the U.S. airline majors. In terms of scheduled passenger-kilometers flown, American rose from the middle of the pack to the top of the world between 2014 and 2016. If it doesn’t continue to offer cheaper flights, it could easily see more customers switch to smaller carriers like Spirit (SAVE) or airlines that are known for having better customer service like Delta.

Overvalued for now

Given its relatively high operating leverage and weak pricing power, which will continue to weigh on profitability, American’s profits and its stock price could both take longer to recover than expected.

According to the GuruFocus Value chart, the stock’s intrinsic value will not catch up with its current price of around $20.17 until the end of 2023. The GF Value is based on a stock’s historical returns, historical earnings multiples and analyst estimates of future earnings.

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All things considered, it seems like American Airlines remains overvalued for now. Even as it recovers, the company will need to prove its dedication to reducing debt in order to avoid toppling out of the sky at the next headwind.

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