CHICAGO- American Airlines (AA) Group Inc (NASDAQ: AAL) remains an overlooked player in the airline stock market due to unfounded fears surrounding debt, which have already been resolved.
The airline sector is gearing up for a record-breaking holiday period, despite the stock market largely ignoring the surging demand in passenger travel.
American Airlines Thrives with Traffic Surge
Before Independence Day, the Transportation Security Administration (TSA) predicted a booming holiday travel season, with an estimated 17.7 million passengers expected to travel during the 7-day period through July 5.
The peak travel day of the holiday weekend was anticipated to be Friday, with an estimated 2.82 million individuals passing through TSA screening.
This figure would surpass the previous single-day travel record set on Friday, June 16, when nearly 2.8 million passengers were screened. 2019 the peak Independence Day travel day was Sunday, July 7, with 2.79 million passengers screened.
The holiday period got off to a strong start, with traffic on both days prior to the weekend showing a 30% increase over 2019 levels. On June 30, approximately 2.9 million passengers traveled, signaling the booming demand for air travel.
Weekly traffic has surpassed 2019 levels, proving that passenger demand is not the issue it once was when COVID-19 shut down airlines.
American Airlines Ensuring Strong Future Profits
One remarkable aspect of American Airlines and other airlines is the lack of conviction that earnings will bounce back to pre-COVID levels.
Delta Air Lines (DL) has already forecasted that its EPS for 2025 will match pre-COVID levels, yet its stock has yet to regain the $60 level from 2019.
American Airlines is another stock that seems to be stuck in disbelief regarding whether it will reach its EPS target of $2.50 to $3.50 for the year. However, the real story lies in the potential for earnings to recover even higher.
The airline was achieving an EPS of $4+ before the pandemic, but factors such as debt levels and additional shares outstanding have impacted the ability to return to those levels immediately.
Despite these challenges, American Airlines is currently trading at only $18, and the airline has already demonstrated a strong recovery with a massive Q4 EPS of $1.17, surpassing the Q4’19 level.
It’s important to note that the airline has significantly reduced net debt levels heading into Q2.
Reduced Net Debt
At the end of Q1, American Airlines had reduced net debt to $23.7 billion, a substantial decrease from its peak levels. The airline is now only a short distance from its net debt of approximately $20.4 billion at the beginning of 2020.
Equally significant is American Airlines’ improvement in net interest expenses. Previously, the airline held excess cash balances as a precaution against potential shutdowns, leading to higher total debt levels and excessive interest expenses.
However, with the rise in interest rates, the excess cash has started generating sizable income, allowing the airline to repay debt and decrease net interest income from nearly $500 million in mid-2021 to only $415 million in Q1’23.
During Q1 alone, American Airlines generated an impressive $3 billion in free cash flows. The airline has reduced its total debt by a staggering $9 billion during this period and expects to reach up to $11 billion in debt repayments by the end of the year.
Further resulting in a net leverage ratio below pre-COVID levelsSubheading: Positive Cash Flow and Potential for Higher EPS
Expenses
Despite the progress made in cash flows, American Airlines still pays approximately $175 million per quarter in higher interest expenses.
However, the company has a total cash reserve of approximately $12.5 billion, providing an opportunity to pay down higher-costing debt and ultimately reduce interest expenses. This move alone could boost EPS by $1.
Considering the cash flows generated in Q1’23 and the booming traffic, investors should no longer doubt the ultimate outcome for American Airlines.
The airline has provided guidance for a $3 EPS in 2023, and addressing the interest expense issue alone could raise this target to $4 within a few years.
Analysts even forecast a promising $4.83 EPS in 2025, making it crucial for investors to seriously consider this number a legitimate estimate for a stock currently trading at only $18.
Bottom Line
In conclusion, American Airlines has experienced a significant rally in recent months, but, likely, $18 is just the beginning. The airline has successfully managed its debt, defying the expectations of many market observers.
With the potential for an EPS of $4+ within a few years and trading below 4x the 2025 EPS targets, American Airlines has ample upside ahead. Investors would be wise to consider the favorable prospects offered by this stock.
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