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American Airlines stock story updated with additional analyst commentary.

DALLAS ( TheStreet) -- A veteran airline analyst is recommending American ( AMR - Get Report), saying the carrier's lagging shares have the highest upside potential among the airlines.

JP Morgan analyst Jamie Baker called American "our top equity pick among U.S. airlines" in a report issued Wednesday, noting: "We gravitate toward the underdog.

"We expect AMR to turn a significant margin corner in 2011, as alliance immunity, rising industry labor costs and a shifting Latin/Pacific supply dynamic reverse its multiyear relative margin decline," Baker said. If AMR can in fact maintain margins in line with the industry's, its "upside equity potential is expected to exceed that of all other U.S. names we cover," he said.

At the moment, American has the highest percentage of sell and hold broker ratings of any U.S. legacy carrier, Baker said. That is not surprising, given its "woefully weak" year-to-date equity performance. For the year, American shares are up 2%. In contrast, the Amex Airline Index ( XAL) is up 46% while the Standard & Poor's 500 Index is up 7%.

Last month, American reported its first profitable quarter in three years.

In mid-afternoon trading on Wednesday, American shares were up 37 cents to $8.22, helped not only by Baker's report but also by a report from Standard & Poor's, which upgraded the carrier's credit-rating outlook to stable from negative while affirming a B-minus rating.

Baker said shares could rise to $40. In recent years they have been held back by concerns over labor costs, which are considered to be the industry's highest. But Baker said "we expect industry labor costs to migrate toward AMR levels, starting with United ( UAL - Get Report) and followed by US Airways ( LCC.).

American has said it has a $600 million annual labor cost advantage relative to peers. Additionally, its executives have also said they expect net income to increase by $500 million annually as a result of transatlantic and transpacific antitrust immunity as well as a new hub-focused route strategy.

American CEO Gerard Arpey maintains the carrier has taken a different approach then its pears, electing not to reduce costs in bankruptcy. "This company stands for something, more than just any old company," Arpey said in a recent interview with TheStreet. "Gradually, it will emerge as a successful company that honored its commitments and its pension obligations and that was guided by principles of doing what's right.

Baker also said that capacity growth is moderating in Latin America, where American is the strongest carrier, at the same time it is accelerating in the pacific, where Delta ( DAL) and United are stronger.

"While the lack of company aggression in pursuing alternative strategies has been disappointing, in our view, that doesn't stop us from identifying where potential equity upside is greatest," Baker wrote. "We think we've found it."

-- Written by Ted Reed in Charlotte, N.C. .

>To contact the writer of this article, click here: Ted Reed