Merrill Lynch has downgraded American Airlines stock to a ‘neutral’ rating just as airline CEO Doug Parker elected to take all his compensation in stock.
Remember that neutral means sell (and sell means build a shelter and accumulate canned goods and bullets). Historically an investment firm wouldn’t rate a sell (or likely even neutral, since ‘buy’ is considered neutral) if they hoped to get business from that firm in the future.
I think that airline stocks generally have had a good run, and there’s more downside risk than upside at this point. That’s true for the US industry as a whole rather than for American in particular.
It’s also true that they’ve already given up much of the gains from the past year. So this may be Merrill just shutting the proverbial barn door. Remember, the factors they see (and I see) aren’t secret or proprietary, so they may already be priced into the stock.
Of course I am not a professional investor, I invest predominantly in low cost, broad-based stock index funds. So what do I know? Then again Parker went all-in on his airline’s stock, and he’s an airline CEO not an investor (though presumably at least someone with insider knowledge).
Nonetheless, it’s reasonable to see the industry as a whole underpeform the market.
- While we no longer face $100 oil, fuel costs are up of late, and there may be greater risk of increases than likelihood of decreases although much of this depends on Chinese consumption.
- Airlines have practiced capacity discipline over the past several years but with profits up and costs down are beginning to get more aggressive. Much of American’s increased capacity just comes from adding seats to existing aircraft, but the industry as a whole is beginning to grow capacity.
- The industry is cyclical, both with commodity prices (fuel) and the economy (demand for business travel). The first quarter showed negative growth. Nonetheless, airlines made money and in their most challenging quarter. Where the economy goes will drive airline profits and determine if they can absorb capacity growth.
- With backward-looking substantial profits, we may see increased friction with labor groups as they demand bigger pay packages.
I think the Merrill report is wrong to lead with the risk of reservation systems-integration. It’s not a zero risk, but:
- They’ve already merged frequent flyer programs, and that went well — doing this in stages is different from the past failed integrations like United/Continental.
- They’re reducing the risks of the reservation system cutover by draining down US Airways reservations before moving data. Running the US Airways operation on the American platform after mid-October isn’t without challenges, but the data migration should work out well.
Goodness knows I don’t give investment advice. I’m unlikely to outperform really smart people who spend all of their time looking for the slightest advantage and who still get killed half the time.
But I’m skeptical that airline stocks will continue their meteoric rise. And other than recognizing there’s some folks who believe United’s operation can only get better starting from a low base and who think that’s not already baked into their share price, I’d guess that the industry would likely tend to move together rather than singling out American’s stock (as we see from the stock price chart above). And if history has taught us anything it’s that airlines are always a strategic short-term play, rather than a long-term investment.