New American may not meet the classic definition of being a sleeper stock, one that is likely to achieve unexpected success. Rather, it is a sleeper because of the promise that could be unleashed by having the America West management team take over American's vast route network, and perhaps because of all the lessons learned from previous mergers including the 2005 America West/US Airways combination.
"AAL shares appear to be trading as if this is a typical merger: we believe there is more to the story," wrote Imperial Capital analyst Bob McAdoo in a report issued Monday. McAdoo said he expects schedule changes visible as early as January will show the new management's impact.
In a previous report, McAdoo said the America West team could find $1 billion worth of revenue gains by eliminating unprofitable flying, which would buttress the value of the remaining seats.
Additionally, JP Morgan analyst Jamie Baker wrote
last week that "the earnings power of new American appears sorely underappreciated by the equity market, in our view." Baker has a $37 target price and has put the shares on the firm's "analyst focus list."
So expectations are high for the shares. New American traded for the first time on Monday morning at $23.95, after a one-for-one exchange with shares of US Airways, which traded as LCC. American shares closed Wednesday at $25.99, up $1.11 on a day when shares in every other major airline were down.
When the same management team, headed by CEO Doug Parker, President Scott Kirby and Chief Financial Officer Derek Kerr took over at US Airways in 2005, they quickly made improvements, primarily capacity cuts. In the first quarter as a merged company, revenue per available seat mile on the US Airways routes improved by 27.7%, a very high number. So Wall Street has faith in the team.
On Monday, CRT Capital analyst Mike Derchin initiated coverage with a buy rating and a target price of $31; he called AAL "one of our favorite ideas." Derchin said equity distributions over the next 120 days should create buying opportunities. He said labor goodwill, a strong cash positioned and a strengthened OneWorld alliance, due to the addition of the US Airways destinations, will all benefit the shares.
"The main risk is now merger integration," Derchin wrote. "We believe management knows from personal experience and recent industry successes and failures how to get it right."
In an interview Monday, Terri Pope, US Airways/American vice president for Charlotte Douglas International Airport, said she has managed through four mergers at US Airways. "I've seen planning in the last 24 months that I had never seen in those four mergers," Pope told reporters on Monday. One lesson, she said, is that "it's not about how fast you make it happen, but that you make it happen the right way."
The point is that not only has the airline industry learned from the closely watched mergers over the past decade, but also that throughout its management ranks US Airways has people with broad experience in overseeing mergers. That was not the case at Delta (DAL) or United (UAL), which both stumbled in completing their mergers.
In his note, Baker wrote that new American's EBITDAR margins already rival Delta's and exceed United's" and we expect AAL to widen its lead going forward." Of the three, he said, Delta presents the least risk, with "little being asked of management besides staying the course, (while) United still requires heavy lifting, (yet) shares already trade at a premium following management assurances to do better.
"This leaves AAL, with a management team that has tackled integration in the past and is starting from a base of profitability already rivaling DAL's," Baker wrote. Like McAdoo, he warned that emergence from bankruptcy, accompanied by equity distributions, can lead to selling pressure. Delta, he said, lost 18% of its value in the first month after emerging from bankruptcy, while United lost 10%.
Wolfe Research analyst Hunter Keay also said he sees favorable comparisons with United and Delta. In a recent report, Keay wrote that new American's "large discount to Delta and United is simply too much."
Keay also suggested "that the AAL merger integration risks are overblown (because) labor is large mollified entering the process and hard knocks IT experience from US Airways' prior merger (same executives, same reservations systems) should yield valuable lessons learned." He has a $39 price target and calls AAL his top pick.
Written by Ted Reed in Charlotte, N.C.
To contact this writer, click here.