Analysts Step Up to Defend Ailing American Airlines

American Airlines

With the huge decline in air travel lately, airlines have been dealt a big blow and have had to come up with ways to survive. Is American Airlines too sick to put money on now?

Among the major air carriers in the U.S., American Airlines has held the most debt, but they had a good plan on paying enough of it down more over the next couple of years to have it more manageable and get them in a more comfortable position.

It’s not that the stock has done very well over the last couple of years, falling from a high of $59.08 on January 16, 2018 all the way to $28.23 two years later, on January 16 of this year. That’s a two-year loss of over 50%, and while Warren Buffett may have held on through this, anyone who is willing to pay this big of a price in a position at a time where the future isn’t exactly that bright hasn’t acted wisely under any conception and just being in the stock in the first place to become subject to the big fall since is a self-inflicted wound.

The idea with holding stocks is supposed to be to make money on them, not lose money, and when you see a stock in such an obvious downtrend, that’s not a situation where the odds are in your favor, especially with so many other stocks actually delivering some nice gains instead over this time.

We cannot even imagine how anyone could justify such a hold, as it is not even possible to defend such a move. Without exception, anyone who held this stock over the last two years has made a huge mistake and need to seriously re-evaluate their thinking about not only this play but their investing strategies in general, as anything that would permit such a poor decision is in serious need of revision.

As we watched American bleed so much over this time, it can pay to be on the lookout for a reversal, but we can’t just jump in blindly and hope for this, we actually need to see it materializing first. Up until the 2020 crash, we did not have any signs of this, but the stock going below $9 a share and then rebounding a bit from there was this time.

The previous leg of the decline was more organic, reflecting the market’s diminished view of the stock, and while there have been several opportunities to trade the ups and downs along the way, these were of too short of a duration to be practical for investors. These were moves of just a few weeks in duration and even too short for position traders, let alone investors, and did also require some serious skill to navigate profitably.

On the scale that investors need to use, there was no bounce here, just a long slide downhill. To want to be in this stock on the long side, we need to avoid sliding down hills and, at best, instead look to jump on after it has hit the bottom in predictable enough way and is now starting to climb back up.

We also need a reason for this to be happening, as we’re not just looking to play a small move when we invest but instead need to play reversals that are likely to be more enduring, real changes in the way that the market sees a stock that will turn it from bearish to bullish. If you don’t see this, you have no business either buying or holding a bearish stock like this because the probability of you losing money is just too high.

It is not just about avoiding losing over a period of time with a stock, although if the odds are that you will lose, that’s enough to make us want to avoid a stock altogether. There is a second condition though, the need for a stock to not just keep from losing but to also deliver competitive returns versus other stocks we could be into instead, and this is what so many people don’t account for enough.

U.S. airline stocks in general, when viewed from the JETS ETF, have held up a lot better over the last 2 years, running fairly flat until the crash in February. Treading water in a bull market falls well short of the reasonable standard for holding stocks though. There was no good reason to be in this one either, as the growth potential of these stocks and this ETF was too low to be of any interest.

That all changed though when COVID-19 had everyone scared to fly, when passenger levels dropped off by 95%, with no real timeline to get back to normal. Airlines have significant fixed costs and this required them to deplete their cash reserves and then borrow enough on an ongoing basis to keep from going under.

Of the four major U.S. airlines, American Airlines is the weak kid on the block, the one that has a more compromised immune system that is less able to deal with the impact of such a virus. There has been some discussion about whether the new landscape will be able to support all of these airlines, and if not, American is likely to be the odd one out, the one that declares bankruptcy, gets acquired, or both.

No one will dispute that the risk with American is higher than with the other major airlines, and even though analysts tell us that American “should” be able to avoid bankruptcy proceedings, should does still imply risk.

All Airline Stocks Should Benefit from Here, But Only So Much and for So Long

Like all airline stocks, American got hammered by the coronavirus infection beyond what the market eventually decided was appropriate, although all stocks were visited with much bigger declines than they should have from a valuation standpoint, and that’s just what happens when markets panic. Even the best stocks like Amazon took a beating for a while, and their business improved from the stay at home orders instead of being knocked to the mat like the airline stocks were.

Once things settled down and we moved toward equalizing the value of these stocks more in line with value, undoing some of the excesses that panic had caused, all of these airline stocks became a fabulous buy. American particularly benefited since they took a few extra punches due to their more tenuous business situation and more than doubled its price versus the low up until about a week ago when things started to turn the other way somewhat.

American and other major airline carriers took a pretty big hit from recent concerns about the makings of a second wave of this pandemic, and since this was based upon mere illusion, as the pandemic is clearly still in decline, this adds to the bullishness of entering these stocks right now as this represents an overselling similar to the big one, one that stands to be corrected.

While the market has come back a good way from that, airline stocks have not shaken this off yet and the gap between where they are now and where they were on June 8. While a move backing off like it did would give us plenty of reason to be concerned and perhaps even jump off airlines, this situation is far different, and this is not anything we should be concerned about at all. Jumping in now also allows us to capture some of the gains that people have missed out by waiting on the sidelines, what was just given back.

In spite of American’s additional burden, where they should be able to avoid bankruptcy but will get closer to it than we may like, several analysts are coming to the defense of American and still like it as a buy.

A buy rating from an analyst doesn’t mean that we should just buy something, as they have stocks at a buy that are in decline and stocks that no one in their right mind should want to be in. Often, these stocks will be rated a hold, as if it makes sense to hold stocks when they are performing poorly, and of course it does not. There are a lot of cases where bad stocks that we should steer well clear of are rated buys though.

If we really want to just go with the rating of analysts, we definitely should toss everything but their highest rating, outperform or similar, and if a stock is not expected to outperform, there’s no reason to ever be in it as this is the kind of performance we want and there’s no need to settle here.

We still don’t just want to take the word of one analyst no matter how good they may be, as we need to think of this process as a filter and the more filtering the better. We then would look to build our stock portfolios by seeking the best of the best based upon the consensus of these ratings if this was to be the plan. This isn’t to say this is the best way or even a good way, but it is the best way if we are going to allow these ratings to guide us.

This process is not unlike going to a donut shop where you don’t know how the various donuts taste and are asking for advice from the counter person. You do need to ask as you will fall well short of your goal if you just select them randomly. The person points out the best tasting ones, some that aren’t quite as good, and some not very good at all.

We Need to Prefer Good Stocks Only, The Best We Can Find

It wouldn’t make sense to buy some of the lesser ones, the buys, and especially wouldn’t make sense to buy any of the crappy tasting ones, the holds. However, we want the best ones, so we aren’t just going to take this person’s word for it, and we will go on the internet and look at what several other people think and pick ones that there is also a consensus of being good, a consensus to outperform.

The fact that most analysts rate American as a hold or worse provides us with more than enough consensus to judge this stock on this basis at least, despite a few seeing it as a buy and one even rating it outperform. We want and need a consensus to outperform, not one to underperform.

We don’t put much stock in the opinions of analysts anyway, and while people may want to read these things, they aren’t sufficient for anyone to be basing their investment decisions on to be honest. They only look at a rather small part of the story, near-term fundamentals, and while we may want to consider that to some degree when investing, there are other things to account for that they don’t look at, like price action.

We want to know what the market thinks of the stock, not just what these folks think of it, and need to go to the source for that, their charts. Huge debt or no huge debt, even drowning in it, has not served to keep the market from driving up American Airlines stock, and if that can be counted on enough to continue, that’s all we may need to know right now.

There are two distinct situations that this stock is presenting us with right now, which is the potential for this correction to continue, and its longer-term prospects. There simply isn’t a good reason to want to stick with this or any of the airline stocks past the correction period, as they put more and more planes in the air and the market somehow acts pleasantly surprised and raises the prices of these stocks significantly.

We saw this recently, and while it is hard to imagine that the market could not have seen this plan on increasing flights coming, we don’t need to ask why and instead need to be grateful that this is happening in such a predictable fashion. Markets regularly over-discount events though and all it takes, often times, is the expected to have this gap filled, and airline stocks display this in action beautifully now.

Beyond that, these will at best go back to being crappy stocks, and whether American keeps its title of the crappiest or not doesn’t even matter, because the potential here remains well below what we could get in many other stocks whose businesses are actually growing, doing what stocks are supposed to be doing if you want to make money holding them.

While people simply abuse the concept of diversification, putting them in situations where they diversify way beyond what it would make actual sense to, where the benefits become negligible and the costs of diluting your returns are much higher, we might want to buy several types of donuts, but we do need to stick to selecting among the good ones.

In terms of that’s left to correct the panic-driven overselling that is still likely holding back airline stocks significantly, American would be as good as any, as all are due for a raise and probably a similar one. American may earn a little more, but not enough that we should want to put all of our eggs in this basket and take on the corresponding level of higher risk with this stock.

The added diversification that the JETS ETF provides is a great idea in this situation, where we can own a share of all of the major airlines and avoid stock risk completely, leaving us to concentrate on the improvement in the outlook of the sector itself as it comes more back on line.

All of these airlines are set to outperform over the next while anyway, and investors need to realize that it does not take a long-term commitment to take advantage of this rather special situation.

Monica

Editor, MarketReview.com

Monica uses a balanced approach to investment analysis, ensuring that we looking at the right things and not confined to a single and limiting theory which can lead us astray.