Why American Airlines Is Still The Best Airline Stock
Despite its recent pullback, the airline industry group has still shown strong price momentum and profit growth, while maintaining attractive valuations.
Our algorithms expect American Airlines to outperform over the next twelve months due to strong growth, relative undervaluation, and the bullish sentiment of the “smart money.".
We’re also bullish on United Airlines, and have Alaskan Airlines, Jet Blue, and Southwest on our watch list.
Despite the recent downgrades from Deutsche Bank (and the subsequent after hours price drops), we feel that the airlines industry group still offers some great investment opportunities, and that American Airlines (NASDAQ:AAL) is the best amongst them. This article will explain our sentiment through a statistical top-down analysis of the industry group, highlighting stocks that are expected to produce significant excess returns (i.e. alpha) over the upcoming 12 months. Our algorithms estimate 12-month alpha by comparing a stock's value, growth, and "smart money" profile to the overall market. Then, we cross-reference this profile with the average excess returns generated by stocks with similar profiles in the past. We focus our analysis on certain valuation and growth metrics that have been academically proven to predict stock returns.
Before delving into an analysis of specific airline stocks, we'll first analyze how the overall airlines group is performing compared to other industry groups. The table below shows how the airlines group is doing on a growth basis, relative to the other sub-groups in the industrials sector.
The airlines group is leading its sector in three of the five most important growth metrics: TTM EPS growth, 6-month price performance and 12-month price performance. The average airline stock has gained nearly 33% in the last year, with gains of over 36% in the last six months, far outpacing the industrials sector averages of 1.92% and 10.80%, respectively. Airline stocks have also had strong profit growth in the last year, with annual EPS growing by over 30%, on average - compared to the industrial sector average of 9.29%. Additionally, the group has been financially efficient, with an average return on assets of 4.28% and an average return on equity of 19.88% - compared to sector averages of 5.08% and 12.07%, respectively. We expect the average airline stock to produce 3.53% of excess return from their growth profile over the n 12 months. Next, we'll analyze how the airlines group is doing on a value basis relative to other groups in their sector:
The airlines group is still relatively undervalued, coming in near the middle of its sector on a valuation basis. The average airline stock has a sales yield of 107% (sales yield is the inverse of the price/sales ratio), an earnings yield of about 5%, and an average dividend yield of 0.85% - compared to sector averages of 72.67%, 5.30%, and 1.48%, respectively. While the earnings and dividend yields leave much to be desired, the airlines group is attractively valued on a revenue basis, with investors effectively getting $1.07 of sales for every $1 they invest. The price-to-book ratio (3.93) and free-cash-flow yield (1.12%) aren't very attractive on an absolute basis either, although they fall roughly in line with the sector averages of 2.71 and 1.66%, respectively. Overall, we expect the average airline stock to produce an excess return of 0.92% as a result of its value profile over the next 12 months. Next, we'll look at how the group's earnings performed relative to analyst expectations in the most recent earnings season.
The airlines group posted strong results on the bottom-line during the most recent earnings season, with 92% of airline stocks beating consensus EPS estimates, and with a remarkable average beat size of nearly 25%. Top-line results were also strong, with 76% of airline stocks beating the consensus revenue estimates, and with an average surprise of 0.41%. Earnings beat rates are important to watch as we've found that stocks that beat analyst estimates are much more likely to keep beating estimates in the future. The average airline stock has an earnings strength rating of 3.5 stars, meaning that we expect mostly positive surprises from the group in the next quarter. Evidently, earnings and revenue results last quarter were incredibly strong, most likely as a result of the improved economy and lower gas prices. Though we anticipate a slower upcoming quarter, we also expect analyst estimates to overcompensate for this slowdown and to remain overly bearish, leading to more future EPS and revenue beats for the group.
As outlined above, the airline group as a whole looks strong on a growth basis, while maintaining some value relative to its sector and the overall market. Next, we will delve into the specific stocks that look poised to lead the group over the following 12 months. Once again, we will focus our analysis solely on growth, value, and "smart money" metrics that have been repeatedly shown to predict stock returns. The table below shows the top five airline stocks based on growth performance:
Each of top five airline stocks has outperformed the market by a wide margin on price performance, profit growth, and efficiency. JetBlue Airways (NASDAQ:JBLU) has had the best price momentum, having gained nearly 85% in the last six months and 108% in the last twelve. However, its relatively weak equity efficiency puts it behind Alaska Air (NYSE:ALK) on an overall growth basis. None of the top five growth stocks have trailed the average 6-month price performance of the overall group (36%), though both American Airlines and United Continental (NYSE:UAL) were slightly below the group's average 12-month price performance of 32%.
American Airlines has had the strongest profit growth and profit efficiency in the group, with annual EPS growing 257% and a return on equity of over 94%. Hawaiian Holdings (NASDAQ:HA) had the weakest profit growth and efficiency of the five, with annual EPS growing 33% and a return on assets below 3%. Within the group, our algorithms expect Alaska Air to generate the most excess return from growth (6.9%) in the upcoming 12-months.
It's also important to consider that of the four large cap airlines stocks, AAL has had the best 6-month price performance, with UAL as a close second.
Next, we'll outline the airline stocks with the most attractive valuation metrics:
Of the top ten airline leaders in value, there are two stocks with extremely attractive valuations, Copa Holdings (NYSE:CPA) and Jet Blue. Copa Holdings was ranked as our #11 growth leader, which is why, despite its attractive valuation; we're not bullish on the stock. Jet Blue, on the other hand, is ranked second in both value and growth, representing a prime 'value with growth' stock. However, its enormous short float of 18% and big insider selling (8% over the last six months), are red flags that neutralize our bullish stance on the stock.
American Airlines, while not exactly a value play, still offers some value to investors from a sales and earnings perspective. Its sales yield (124.5%) and earnings yield (8.4%) are both the third highest in the group, and are ranked in the top 20% of all stocks in the market. Its book value of nearly 17% is definitely not reassuring, nor are its measly dividend yield of 0.8% and free-cash-flow yield of -2.7%. With its value profile in mind, the pros slightly outweigh the cons, and we expect AAL to generate 0.93% alpha as a result of its value over the upcoming 12 months.
Lastly, we'll look at the airline stocks that the "smart money" (insiders, institutions, and short sellers) is most bullish on:
With positive institutional buying over the last three months and a short float of only 2%, American Airlines is the stock with the most bullish "smart money" sentiment of the airlines group. In fact, the airlines group has the least bullish "smart money" sentiment of all major industry groups, with only 4 of its stocks having a bullish sentiment. This is where AAL really stands out. Its institutional buying of 2.35% is the highest of its group and its short float of 2.04% is behind only Southwest Airlines (NYSE:LUV) (1.86%) and Delta Air Lines (NYSE:DAL) (1.99%). While the insider selling of nearly 5% may appear to be a warning sign, it remains a lot lower than the group average of nearly 10%. Finally, AAL also has the highest forward earnings yield of the entire group at 17.9% and a relatively strong profit margin of 6.7%.
Now that we've analyzed the growth, value, and "smart money" leaders of the airlines group, it's time to see which stocks come out on top overall. The table below shows the top five stocks in the group, ranked by the expected price outperformance in the next twelve months:
Unsurprisingly, American Airlines comes out on top with an expected 12-month alpha of 9.11% - 5.77% of the outperformance from its strong growth metrics, 2.40% from the bullish sentiment of the "smart money," and 0.93% from its valuation profile. The stock has also been consistently beating analyst estimates (5 straight EPS beats), giving it a strong 3.5 star earnings rating. AAL is expected to report earnings on April 23rd, with the Wall St. consensus expecting $1.69 in EPS and $9.85B in revenue.
Alaska Air, JetBlue, and Southwest all represent attractive long ideas that are worthy of further research, though their high short floats and recent insider selling are cause for short-term concern. Overall, we feel that the airlines group is showing very strong price momentum and financial growth, while still maintaining a moderate valuation.
Finally, we'll address the recent pullback and negative analyst sentiment towards the group. Deutsche Bank recently downgraded Delta, United Continental, and American Airlines from "buys" to "holds", while subsequently dropping their price targets from $60 to $50, $85 to $70, and $78 to $58, respectively. The reasons for these downgrades are: "the combination of a strong U.S. dollar, greater-than-expected capacity increases by non-U.S. airlines, and decelerating global GDP growth are expected to hit international unit revenue" (source). However, I'd like to note that these new price targets still represent substantial annual returns of 20% for Delta (currently trading at $41.70), 18% for United (currently trading at $59.40), and 21.5% for American (currently trading at $47.74). We feel that the market overreacted to Deutsche Bank's report (all three stocks are down over 5% since its release), and that now may be a good time to invest. Separately, IBD clearly supports our bullish airlines thesis, as the transportation-airlines group is ranked #3 out of 197 industry groups in the IBD tracks. More specifically to AAL, analysts at Zacks recently lowered their rating from "buy" to "sell"; but, surprisingly, the stock has maintained an "A" grade in each of the Zacks "Style Scores" for growth, value and momentum.
We believe that the recent price drawbacks are over reactive, and that the airlines group will continue to prosper over the next 12 months. More specifically, we've highlighted AAL as our favorite of the group, but also remain bullish on UAL. For investors who are less concerned by a high short float, and large insider and institutional selling, ALK, JBLU, and LUV also warrant consideration based on their strong growth and value characteristics.
