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American Airlines (AAL): Are Hedge Funds Right About This Stock?

US Airways acquired American Airlines in December 2013 and took its name. We first recommended this stock at the end of August 2012 when it was trading at $10 per share. It briefly dropped off of our list in November 2012, but we got back in American Airlines Group Inc (NASDAQ:AAL)  in February 2013 when it was trading below $15. With the U.S. economy healthy, the long thesis that American Airlines is a leader in an economically sensitive industry still holds.

Developments/ Catalysts:

American Airlines Group Inc (NASDAQ:AAL) reported first quarter earnings of $1.25 per share on revenue of $9.44 billion. Earnings were lower than in the first quarter of last year because the company’s profits were taxed at 38% versus 0% for last year. When removing the effect of the added taxes, American Airlines’ adjusted earnings per diluted share rose 15 percent.

Despite the stronger operational results, American Airlines’ stock has retreated for several reasons. First, given that crude prices have risen over 70% from their February lows, low crude prices aren’t guaranteed to be a tailwind anymore. Second, industry capacity has expanded faster than GDP, with American Airlines’ consolidated passenger revenue per ASM (PRASM) falling 7.5% year-over-year and consolidated passenger yield declining 7.1%. The major airlines ran into trouble in the previous cycle by expanding capacity too much during the good times, only to report sharp losses when the business cycle turned. Investors are afraid that a replay of the previous cycle could occur. Third, the company’s labor costs has risen. To retain talent, management instituted a new employee profit sharing program that will pay 5 percent of pre-tax profit excluding special items. The profit sharing lowers the total benefit to American Airline shareholders.

While American Airlines Group Inc (NASDAQ:AAL) looks very cheap based on its forward earnings P/E of 5.22, its earnings are overstated because it is making lots of investments that it should have made years ago. AAL spent $5.3 billion on new aircrafts in 2015, and plans to invest $4.5 billion on new aircraft in each of 2016 and 2017. Because only part of that capital investment shows up as annual depreciation in AAL’s financial statements, its EPS overstate its true earnings.

Hedge funds are long AAL, however, because the stock is a value play and the company is returning capital to shareholders. American Airline’s capital returned $1.6 billion to stockholders through share repurchases and dividends in the first quarter and the company’s board authorized an additional buyback of $2 billion. American Airlines Group Inc (NASDAQ:AAL)’s large capital investments today will help it in the long run too. Because it has one of the youngest fleets in the industry, AAL will have lower costs and more cash flow in the future for buybacks and dividends.

Earlier this month, John Lykouretzos of Hoplite Capital Management participated in the Skybridge Alternatives Conference in Las Vegas and said that Hoplite is shorting American Airlines Group Inc (NASDAQ:AAL)’s stock because the investor believes that the company has high costs. Hoplite added that it plans for the bet to pay off in the next 18 to 36 months, as American Airlines Group has a high exposure to rising oil prices and has the highest leverage. However, many investors are still long American Airlines Group and on the following page, we are going to take a closer look at the hedge fund sentiment surrounding the stock.

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