American Airlines Is Downgraded Thanks to Southwest's Growth in Dallas

NEW YORK ( TheStreet) -- In the latest sign that airline industry shares have hit a rough patch, Bank of America/Merrill Lynch on Wednesday downgraded American Airlines (AAL) to neutral from buy.

"American is the most exposed to capacity concerns that have arisen of late given that it goes head to head with Southwest (LUV) in Dallas," wrote Merrill Lynch analyst Andrew Didora in a report.

Additionally, Didora said, "The company faces its biggest integration risk with the reservation system cutover this fall," following the 2013 merger with US Airways. He cut his price objective to $50 from $64.

Didora also cited three other concerns.

For one, Delta's (DAL) May traffic report, issued Tuesday, cited "lower domestic yields" as roughly half of the reason for a 5.5% decline in passenger revenue per available seat mile. Delta PRASM fell 5.5%. The carrier said the other half of the decline was due "to foreign exchange pressure and lower surcharges in international markets."

Additionally, Didora said, American has projected $5 billion in capital expenditures in 2016. Also, the carrier is unhedged and fuel prices appear to be rising.

In trading shortly after the opening bell on Wednesday, American shares were down 59 cents to $43.19. Shares are down 20% year-to-date, the biggest loss among the big four airlines.

The downgrade follows Jim Cramer's assessment Friday that airlines, "right now, are in free fall" and that, if he were a buyer of airlines, he "would wait for the downgrades to happen."

Airline investors are so focused on capacity that two recent stock moves have been triggered by comments by Southwest executives regarding minor capacity variations.

On May 19, Southwest shares fell 3% after Chief Financial Officer Tammy Romo said the carrier foresees 2015 growth of 7% to 8%, up from the previous guidance of 7%.

Didora noted that 13% of American's capacity is offered at Dallas/Fort Worth International Airport. Also, Spirit (SAVE) has recently grown at DFW, and American CEO Doug Parker has said that American will need, in some cases, to match Spirit fares.

Cramer, meanwhile, challenged the theory that American is a good buy because it has a price-to-earnings ratio of 4.

"Every time I have seen that low a price-to-earnings ratio, it is a sign that the future earnings are about to be slashed, maybe slashed drastically," Cramer said.

"If I wanted to own LUV or any of the stocks in the group, I would wait for the cuts to occur," he said. "I would wait for the downgrades to happen ... And only then would I do some buying."

This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.

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