American Airlines’s 13.5% return over the past six months has outpaced the S&P 500 by 7.3%, and its stock price has climbed to $17.53 per share. This was partly due to its solid quarterly results, and the performance may have investors wondering how to approach the situation.
Is now the time to buy American Airlines, or should you be careful about including it in your portfolio? Get the full breakdown from our expert analysts, it’s free.
Why Do We Think American Airlines Will Underperform?
We’re glad investors have benefited from the price increase, but we’re sitting this one out for now. Here are three reasons why AAL doesn’t excite us, plus one stock we’d rather own.
1. Weak Growth in Revenue Passenger Miles Points to Soft Demand
Revenue growth can be broken down into changes in price and volume (for companies like American Airlines, our preferred volume metric is revenue passenger miles). While both are important, the latter is the most critical to analyze because prices have a ceiling.
American Airlines’s revenue passenger miles came in at 58.55 billion in the latest quarter, and over the last two years, averaged 10.6% year-on-year growth. This performance was underwhelming and suggests it might have to lower prices or invest in product improvements to accelerate growth, factors that can hinder near-term profitability. 
2. New Investments Fail to Bear Fruit as ROIC Declines
We like to invest in businesses with high returns, but the trend in a company’s ROIC can also be an early indicator of future business quality.
Over the last few years, American Airlines’s ROIC averaged 1 percentage point decreases each year. Paired with its already low returns, these declines suggest its profitable growth opportunities are few and far between.
3. High Debt Levels Increase Risk
As long-term investors, the risk we care about most is the permanent loss of capital, which can happen when a company goes bankrupt or raises money from a disadvantaged position. This is separate from short-term stock price volatility, something we are much less bothered by.
American Airlines’s $34.53 billion of debt exceeds the $7.29 billion of cash on its balance sheet. Furthermore, its 7× net-debt-to-EBITDA ratio (based on its EBITDA of $3.70 billion over the last 12 months) shows the company is overleveraged.
At this level of debt, incremental borrowing becomes increasingly expensive and credit agencies could downgrade the company’s rating if profitability falls. American Airlines could also be backed into a corner if the market turns unexpectedly – a situation we seek to avoid as investors in high-quality companies.
We hope American Airlines can improve its balance sheet and remain cautious until it increases its profitability or pays down its debt.
Final Judgment
American Airlines falls short of our quality standards. With its shares outperforming the market lately, the stock trades at 7.8× forward EV-to-EBITDA (or $17.53 per share). While this valuation is fair, the upside isn’t great compared to the potential downside. There are superior stocks to buy right now. Let us point you toward our favorite semiconductor picks and shovels play.
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