$American Airlines(AAL)$ $DJIA(.DJI)$
American Airlines provides scheduled air transportation for passengers and cargo. The company together with its regional airline subsidiaries and third-party regional carriers (under American Eagle), operates a hub and spoke model, where nearly all flights originate or fly into one of its hubs. AAL’s hubs in the US include Charlotte, Chicago, Dallas/Fort Worth, Los Angeles, Miami, New York, Philadelphia, Phoenix and Washington, District of Columbia (D.C.), while partner gateways consist of London, Madrid, Seattle/Tacoma, Sydney and Tokyo. AAL is also a founding member of the oneworld alliance, the third largest airline alliance globally. Its cargo division provides a range of freight and mail services with facilities and interline connections available across the globe.
Investment Overview
American Airlines Group (AAL), the largest airline in the world, holds a dominant share of the US domestic market, further reinforced by its expansive route network that covers a vast array of domestic and international destinations. This extensive network not only provides AAL with a significant competitive edge by offering a wide range of travel options to customers but also facilitates seamless connections globally. Additionally, AAL's AAdvantage program, one of the most comprehensive frequent flyer programs in the industry, fosters customer loyalty through numerous benefits and rewards. The airline has strategically concentrated its flying network, prioritising areas of strength such as the Sunbelt hubs, Midwest, Southeast, and London, and has further cemented its leading position through code-sharing agreements with smaller US airlines like JetBlue and Alaska Air. Another focus for AAL is creating more unique origination and destination (O&D) markets through intensive use of its regional jets, leveraging its vast network to optimise connectivity and reach.
Capacity constraints and less effective cost management threaten AAL's profit margins. Unlike its network peers, AAL's earnings recovery lags, with 3Q23 adjusted EPS at just 26.7% of 3Q19 levels. AAL plans for FY24 capacity to remain slightly below/on-par with pre-pandemic FY19 figures, diverging from other U.S. network carriers already operating above those benchmarks. This discrepancy stems largely from AAL's greater reliance on regional carriers, which face pronounced pilot shortages due to less competitive branding and compensation compared to larger network carriers. Consequently, we foresee AAL facing elevated ex-fuel unit costs due to constrained capacity growth, difficulty optimising asset utilisation, and increased pilot salaries. This will likely dent profitability, delaying margin recovery into FY24-25, especially when contrasted with Delta, United, and Southwest, all of whom seem on a more promising recovery trajectory.
High financial leverage remains a significant obstacle for AAL's share price re-rating. Despite adequate near-term liquidity, AAL's financial leverage is the highest among the four largest U.S. airlines. This leverage not only restricts AAL's expansion opportunities and fleet modernisation (though less critical given its relatively younger fleet compared to competitors) but also heightens its vulnerability to rising interest rates. Consequently, AAL is prioritising deleveraging, aiming for a substantial US$15bn debt reduction by the end of 2025. This focus implies a delayed pathway towards resuming shareholder returns. Encouragingly, AAL appears on track, having already slashed over US$11.5bn in total debt by 3Q23.
Macroeconomic weakness could curb discretionary spending on travel. Rising unemployment, coupled with slow wage growth among the general population and higher cost of living in the US could lead to households cutting back on travel spending. Corporate travel could take longer than expected to recover if companies could slash travel budgets because of economic woes.
Persistent cost inflation. Sustained volatility in crude oil/jet fuel prices (especially since AAL is completely unhedged), rapid wage growth of employees in the aviation sector, and other cost pressures could lead to earnings disappointment.
A quicker than expected turnaround to pre-pandemic levels of profitability and reduction in net debt should help to drive a share price-rerating, in our view.
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