American Airlines’s Coverage Relaunch: Successful Turnaround During Bankruptcy Has Added Value

American Airlines (NASDAQ:AAL) emerged from bankruptcy in December last year through a merger with US Airways. As a result, it is currently the largest airline in the world in terms of both passenger traffic and flying capacity. The airline’s stock started trading on NASDAQ from December 9, 2013, at a launch price of $26.40, and since then has risen by over 40% to around $38 currently. In our opinion, this rise in American’s stock is a reflection of its successful bankruptcy period, during which it was able to slash its operating costs significantly.

The American Airlines of today is much better positioned to compete with rivals, Delta Air Lines (NYSE:DAL) and United (NYSE:UAL), both of which also lowered their cost structures in bankruptcy protection and emerged from Chapter 11 through mergers with carefully selected rivals. Delta emerged from bankruptcy in 2008 through a merger with Northwest, while United came out of bankruptcy in 2010 through a merger with Continental. Both these airlines have since posted strong results backed by stable demand environment for flights.

We figure American Airlines is also in a similar position as Delta and United after their emergence from Chapter 11. Consequently, with the demand for air travel likely to remain stable for the foreseeable future, American’s results will likely also improve in the coming quarters. We currently have a stock price estimate of $39.50 for American Airlines, marginally above its current market price.

See our complete analysis of American Airlines here

Bankruptcy Protection Enabled Cost Cutting

The bankruptcy filing was not a complete loss for AMR Corporation’s shareholders. Based on the final distribution date for shares on April 8^th, each AAMRQ shareholder received 0.744 shares of the newly formed American Airlines Group, which on Friday’s close represented a value of nearly $29 per share. During bankruptcy, the carrier re-negotiated its contracts with pilots and other crew members, airport staff, engineers, technicians and other employees. Chapter 11 protection also enabled the company to limit its pension liabilities. American also re-negotiated many of its office and aircraft lease contracts. New contracts signed post these negotiations significantly lowered the carrier’s operating costs. When expressed as a percentage of its passenger revenues, American’s non-fuel costs fell steadily through its two-year bankruptcy period, from November 2011 to December 2013.

However, over the next 18-24 months, we figure American will likely be unable to focus as much on cost cutting, as it will be occupied with integrating its flight network, IT systems, employees and other resources with those of US Airways. However, as in the case of Delta and United, in the long term, American too will likely launch a dedicated cost-cutting program to compete more vigorously with other airlines.

The New American Is Well Positioned In Domestic As Well As International Markets

On the revenue side, American, as a result of its merger with US Airways, will benefit from the synergies that arise from a larger flight network. Corporate customers, who are the bread and butter of network carriers, will now be more attracted to the carrier’s expanded service network. As a result, they will be more likely than before to register with its mileage program, as they can earn and burn miles on a larger flight network. American’s existing customers will also have added incentive to stick with the carrier.

Separately, the complimentary nature of American and US Airways’s flight networks has positioned the combined airline in a much stronger position. American with its hubs at Dallas Fort Worth, New York, Chicago, Miami and Los Angeles has a large network in the domestic U.S. market. The east coast gap in the carrier’s network wherein it was not able to fly customers up and down the east coast has now been plugged by US Airways, which has hubs at Philadelphia and Charlotte with a significant presence in Washington DC. It is important to note here that this east coast market is one of the most lucrative in the U.S.. In all, the combined network of American and US Airways is much better positioned to compete with those of United and Delta.

In the long term, this strong domestic network will catalyze American’s international growth as the domestic network feeds in to the international network. The carrier already has the largest network of any U.S. carrier in Latin America, and its trans-Atlantic service to Europe is at par with those of Delta and United. Its relatively weaker position in trans-Pacific market to Asia will likely also be plugged in the coming years by leveraging oneworld alliance partnerships.

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