American Airlines Group (AAL) Bankruptcy Hides Transition to a “New American” LONG, TP $46 (+30%)
RESEARCH TEAM
Parker Kim, Senior Director Mark Albin, Senior Analyst Charlene Shu, Junior Analyst Christopher Boyd, Analyst Daniel Chen, Analyst Karsic Ma, Analyst
September 2014
Table of Contents
Investment Thesis Parker Kim
Company Overview Daniel Chen
Industry Overview Christopher Boyd
Competitive Overview Karsic Ma
Financial Overview Mark Albin
Risk Overview Charlene Shu
September 2014
Investment Thesis Investors Need More Evidence to be Convinced
AAL P/E Shows Underappreciation
Despite Becoming a Dominant Player
Why does AAL trade at discount to its peers
despite having superior market share and
profitability?
We believe the market is holding American back because
they can’t let go of its turbulent past and are waiting
for merger execution.
September 2014
Investment Thesis The “New American” Isn’t Just a Slogan
AAL Yields Have Grown the Most
Margins Closing in on “Best-in-Class”
Despite negative investor sentiment, we believe that
Network Quality
+
Yield Growth
+
Profitability Gains
Indicate AAL both has been and will continue to be successful in
executing the US Airways merger
September 2014
Company Overview An International Network Carrier with Strong Market Share
Airline Carrier + Airfreight Services Recently emerged from bankruptcy
Fleet of 903 aircraft
Focus on fleet replacement and existing plane retrofitting to develop the most modern, efficient fleet
Largest and most extensive network in the US
Filed bankruptcy in Nov 2011 after it was unable to pay its high debt payments
Agreed to a merger with US airways and restructured its obligations to emerge as a more efficient airline with a stronger network
September 2014
Company Overview Competitive Advantage
Partnerships with other airlines strengthens international network
Frequent flier programs boosts customer retention
#1 network strength makes choosing AAL a logical choice
for frequent fliers
September 2014
Company Overview Post-Merger, US Airways Management Poised to Launch AAL
Doug Parker Chairman & CEO
Scott Kirby President
Derek Kerr CFO
Experienced US Airways management team is key to executing on merger benefits
Synergy Targets: $1.4bn PwC Study: cost-cutting, increased efficiency, stronger network Every performance metric has improved – approaching #1 rank
September 2014
Company Overview SWOT Analysis Indicates Opportunity in Pacific Markets
Strengths
Largest network Largest frequent flier program Experienced management team Excellent profitability margins
Merger execution risk High leverage risk from fleet
improvements
Continued growth in disposable income
Increased business travel aligns with strong business traveler exposure
Increased demand for Pacific travel
Technology-based disruptions in business travel (ie. Skype)
Frequent-flier stealing programs
Opportunities
Weaknesses
Threats
September 2014
Industry Overview Market Forces Make Airlines a Tough but Feasible Play
Large start up costs to purchase planes discourage new entrants
Regulatory issues and airport leasing process make the startup path difficult
Low switching costs and few variations between AAL/DAL/UAL make customer retention difficult
However, frequent flier programs offset this
Competition is based on price which forces razor-thin profit margins
Differentiation difficult, focus is on frequent flier programs + comprehensive network
Leisure carriers are the most susceptible to alternatives in domestic travel
Only 2 major suppliers: Airbus + Boeing Recently, AAL has begun purchasing planes
from Airbus (previously only Boeing) Despite duopoly, pricing power remains fair
HIGH
MODERATE
HIGH
LOW
MODERATE
Porter’s Assessment Industry Dynamic Rationale
Barriers to Entry
Bargaining Power of Buyers
Intensity of Rivalry
Threat of Substitutes
Bargaining Power of Suppliers
September 2014
Industry Overview Post-Consolidation, Pricing Power Should Improve
Favorable Industry Environment
The major US carriers should continue to benefit from a landscape where consolidation has optimized load factors.
Strong demand is producing record load factors. Revenue optimization initiatives combined with structural cost reductions should drive industry profitability up.
September 2014
Industry Overview Industry Improvements Have Seen Tangible Success
US Airlines have begun generating economic returns
(ROIC > WACC) Cost reductions have successfully slowed cost growth
to ~3% per year (even less for AAL)
In the environment of consolidation, airlines have shifted their focus from aggressive market share warfare to optimizing their
internal processes.
September 2014
Competitive Overview Competitive Advantage leads to Revenue Success
AAL revenue per mile is continually growing and has recently moved to #2 in the industry.
While its cost per mile has run in line with network operators.
American holds the most market share in the largest market
segment
September 2014
Financial Overview Seemingly Riskier Balance Sheet is not as Bad as Perceived
We project AAL’s total liquidity position ex-RCF to be between $10-12bn for 2014-2016
...but we forecast Debt / EBITDAR levels to normalize as cash flows mature and debt is paid down.
Liquidity as a % of LTM Revenue has topped the industry for the last year
AAL does have the largest debt position of its network peers…
September 2014
Financial Overview Seemingly Riskier Balance Sheet is not as Bad as Perceived
Free cash flow levels should begin to normalize to begin funding capital structure changes.
September 2014
Financial Overview Comparables Analysis Shows AAL Trades with US and RoW
Global Average: 7.8x
US Average: 7.1x
AAL 7.6x
September 2014
Financial Overview Comparables Analysis Shows AAL Trades with US and RoW
EV/EBITDAR
RO
IC
September 2014
Financial Overview AAL Represents Strong Upside Despite Negative Sentiment
2013A 2014E 2015E 2016E
EBITDAR, adj 5,744 7395 8779 9678
% Margin 14.2% 17.2% 19.4% 20.4%
Taxes -107 363 20 25
NOPAT 5,851 7,032 8,759 9,653
Capex -2,143 -2,813 -3,438
D&A 1,132 1,272 1,307 1,344
Change in NWC -150 -200 -300
Unlevered FCF 6,011 7,053 7,259
PVFCF 5,869 6,261 5,858
Projected Period EV 17,988
Terminal EV @ 4.7x 36,707
Enterprise Value 54,695
Less: Debt 22627
Plus: Cash 1140
Equity Value 33,208
Fully Diluted Shares Outstanding 720.5
Share Price $46.09
Blended UAL/DAL 2015E EV/EBITDAR, current EV/EBITDAR: 7.1x
Consensus estimates for EBITDAR
+30% upside
September 2014
Financial Overview Model Drivers: Unit Costs, Pricing, Utilization
2013A 1Q14A 2Q14A 3Q14A 4Q14E 2014E 2015E 2016E
Operating Statistics
RPMs 215,541 50,886 57,194 58,642 53,518 220,240 225,526 230,262
Y/Y change (%) 2.7% 1.7% 2.5% 2.1% 2.4% 2.2% 2.4% 2.1%
ASMs 259,914 63,392 68,090 69,119 65,232 265,833 272,213 277,385
Y/Y change (%) 2.1% 2.0% 3.1% 2.0% 2.0% 2.3% 2.4% 1.9%
Number of Aircraft in Fleet 1528 1537 1541 1540 1538 1538 1538 1538
Change since prior period end 38 9 4 -1 -2 -2 0 0
Fuel Price / gallon $3.08 $3.10 $3.03 $2.94 $2.99 $3.02 $3.05 $3.07
ASMs / gallon 60.5 61.2 61.3 61.6 61.7 61.5 61.3 61.6
Fuel cost as % of OpEx 34.9% 34.7% 33.8% 34.3% 33.9% 34.2% 34.6% 34.2%
Revenue & Costs / ASM
Yield (cents) 16.49 17.03 17.34 16.84 17 17.05 17.53 18.02
Y/Y change (%) 2.0% 3.2% 6.5% 2.0% 1.9% 3.4% 2.8% 2.8%
PRASM (cents) 13.67 13.67 14.57 14.28 13.95 14.13 14.53 14.96
Y/Y change (%) 2.6% 2.9% 5.9% 2.2% 2.3% 3.3% 2.8% 3.0%
CASM (cents) 9.13 9.75 9.31 9.15 9.46 9.46 9.38 9.57
Y/Y change (%) -2.5% 3.7% 2.4% 2.1% 2.1% 3.6% -0.8% 2.0%
Margins
EBIT Margin 8.1% 5.9% 14.5% 14.3% 10.6% 11.3% 13.8% 15.0%
Y/Y change (bps) 443bps 294bps 456bps 327bps 274bps 274bps 250bps 120bps
EBITDAR Margin 14.2% 12.2% 20.1% 20.0% 16.9% 17.2% 19.4% 20.4%
Y/Y change (bps) 459bps 294bps 415bps 305bps 266bps 298bps 218bps 103bps
Historical Projected
September 2014
Risk Overview General Risk Overview
Union Integration Fuel Price Risk Labor Cost Control
Association of Professional Flight Attendants voted last Wednesday and reached a 5-year agreement with AAL.
Integration issues between LCC-AMR unions resolved with this.
AAL has invested in newer and more comfortable planes to keep up with competition and lower fuel consumption.
Fuel costs represent ~35% of OpEx but should approach 32-33% by 2016.
Contract lasting through 2019 to be signed in December- includes modest 2% pay raises and shortening of pay ladder.
Overall should improve quality of life for personnel.
September 2014
Conclusion Investors aren’t Seeing the “New American”
Low Valuation
Strong operational success
Profitability gains
Investors are waiting to buy AAL because they are
afraid its recent merger will fail.
In reality, AAL has already begun to exhibit signs of merger success and could end up being the star of
the industry.
American Airlines Group (AAL) Appendix September 30, 2014
Research Team
Parker Kim, Senior Director Mark Albin, Senior Analyst Charlene Shu, Junior Analyst Christopher Boyd, Analyst Daniel Chen, Analyst Karsic Ma, Analyst
September 2014
Valuation Overview Revenue > EBIT Projections
2013A 2014E 2015E 2016E
Total Passenger Reveue 35,542 37,557 39,525 41,477
Y/Y change (%) 4.7% 5.7% 5.2% 4.9%
Cargo 830 861 888 897
Y/Y change (%) 0.1% 3.7% 3.1% 1.0%
Other 4,047 4,612 4,913 5,060
Y/Y change (%) 5.3% 14.0% 6.5% 3.0%
Total Operating Revenues 40,419 43,030 45,326 47,434
Y/Y change (%) 4.7% 6.5% 5.3% 4.7%
Fuel and Related Taxes 11,109 10,945 11,379 11,639
Salaries, Wages, and Benefits 7,887 8,422 8,585 9,146
Regional Op Expense 6,417 6,619 6,653 6,836
D&A 1,132 1,272 1,307 1,344
Aircraft Rent 1,336 1,275 1,215 1,227
Maintenance, Materials, and Repairs 1,927 1,916 1,963 2,002
Other Operating Expenses 8,032 7,734 7,966 8,133
Total Operating Expense 37,840 38183 39068 40327
Y/Y change (%) 0.6% 0.9% 2.3% 3.2%
EBIT 2,579 4847 6258 7107
Y/Y change (%) 158.4% 87.9% 29.1% 13.6%
September 2014
Valuation Overview Revenue > EBIT Projections
2013A 1Q14A 2Q14A 3Q14A 4Q14E 2014E 2015E 2016E
Operating Statistics
RPMs 215,541 50,886 57,194 58,642 53,518 220,240 225,526 230,262
Y/Y change (%) 2.7% 1.7% 2.5% 2.1% 2.4% 2.2% 2.4% 2.1%
ASMs 259,914 63,392 68,090 69,119 65,232 265,833 272,213 277,385
Y/Y change (%) 2.1% 2.0% 3.1% 2.0% 2.0% 2.3% 2.4% 1.9%
Number of Aircraft in Fleet 1528 1537 1541 1540 1538 1538 1538 1538
Change since prior period end 38 9 4 -1 -2 -2 0 0
Fuel Price / gallon $3.08 $3.10 $3.03 $2.94 $2.99 $3.02 $3.05 $3.07
ASMs / gallon 60.5 61.2 61.3 61.6 61.7 61.5 61.3 61.6
Fuel cost as % of OpEx 34.9% 34.7% 33.8% 34.3% 33.9% 34.2% 34.6% 34.2%
Revenue & Costs / ASM
Yield (cents) 16.49 17.03 17.34 16.84 17 17.05 17.53 18.02
Y/Y change (%) 2.0% 3.2% 6.5% 2.0% 1.9% 3.4% 2.8% 2.8%
PRASM (cents) 13.67 13.67 14.57 14.28 13.95 14.13 14.53 14.96
Y/Y change (%) 2.6% 2.9% 5.9% 2.2% 2.3% 3.3% 2.8% 3.0%
CASM (cents) 9.13 9.75 9.31 9.15 9.46 9.46 9.38 9.57
Y/Y change (%) -2.5% 3.7% 2.4% 2.1% 2.1% 3.6% -0.8% 2.0%
Margins
EBIT Margin 8.1% 5.9% 14.5% 14.3% 10.6% 11.3% 13.8% 15.0%
Y/Y change (bps) 443bps 294bps 456bps 327bps 274bps 274bps 250bps 120bps
EBITDAR Margin 14.2% 12.2% 20.1% 20.0% 16.9% 17.2% 19.4% 20.4%
Y/Y change (bps) 459bps 294bps 415bps 305bps 266bps 298bps 218bps 103bps
Historical Projected
September 2014
Appendix
http://online.wsj.com/articles/american-airlines-flight-attendants-reach-tentative-agreement-1411164253
http://www.dallasnews.com/business/airline-industry/20140919-american-airlines-reaches-tentative-agreement-with-flight-attendants-union.ece
https://www.iata.org/pressroom/facts_figures/fact_sheets/Documents/fuel-fact-sheet.pdf
http://marketrealist.com/2014/07/why-american-us-airways-merger-was-conditional/
http://www.aa.com/i18n/amrcorp/corporateInformation/facts/measurements.jsp
http://phx.corporate-ir.net/External.File?item=UGFyZW50SUQ9MjI0MDU2fENoaWxkSUQ9LTF8VHlwZT0z&t=1
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http://phx.corporate-ir.net/External.File?item=UGFyZW50SUQ9NTQ2NTEwfENoaWxkSUQ9MjM4MDU0fFR5cGU9MQ==&t=1
http://phx.corporate-ir.net/External.File?item=UGFyZW50SUQ9NTU1MzM4fENoaWxkSUQ9MjUyMDU1fFR5cGU9MQ==&t=1
http://phx.corporate-ir.net/External.File?item=UGFyZW50SUQ9NTU1MzY0fENoaWxkSUQ9MjUyMDg4fFR5cGU9MQ==&t=1
http://aviationblog.dallasnews.com/2013/03/ceos-american-airlines-us-airways-will-bring-nothing-but-good-things.html/