The airline industry has historically had poor returns for investors, but 2014 has been an exception, with American Airlines Group (NASDAQ:AAL) being one of the best performers. But the rise of American Airlines and the industry as a whole has several key reasons behind it.
Making it official
In 2011, American Airlines was a bankrupt airline, with most analysts expecting shareholders to receive nothing. But in 2013, American Airlines announced its plan to merge with US Airways to create the world's largest airline and give old American Airlines shareholders a piece of the pie.
The merger became official last December, when the new airline began trading as American Airlines Group and allowed investors a chance to buy a piece of this newly merged airline.
While it's tough to gauge investor behavior, it is reasonable to expect that many investors who were interested in this new airline combination wanted to wait until the merger became official and shares began trading. Investors who bought shares over time quite likely helped contribute to the share price rally in January, when American Airlines shares rose 34%.
As analysts digested the full effect of the American Airlines-US Airways merger, earnings estimates for 2014 and 2015 have risen sharply. In December, average estimates for 2014 earnings per share were just over $2.50 per share, but they rose to nearly $3.00 per share by January.
Estimates rose even higher after January, hitting $4.50 per share in February and rising to $5.22 today. Estimates for 2015 also rose from $3.50 per share in January to nearly $6.50 per share today.
As estimates have risen, investors have taken another look at the future earnings power of this airline. Combined with positive notes from analysts that accompanied these estimate increases, many investors have seen value in the airline and driven shares higher.
Dividends and buybacks
American Airlines has been buying back shares for most of 2014, but capital returns got another boost in July, when the airline announced $1 billion in share buybacks and a $0.10-per-quarter dividend. With this announcement, American Airlines joined Delta Air Lines and Southwest Airlines as major airlines paying dividends to their shareholders.
Although shares have performed poorly since the announcement, such an announcement has been expected for much of the year, and it's quite likely that investors have pushed shares higher on this expectation. Furthermore, outside factors may be to blame for this slide, since the announcement came as tensions continued to boil between Russia and Ukraine following the downing of Malaysia Airlines flight 17.
Airline profits are surging across the major carriers, thanks to improving travel demand and more fees and extra services. American Airlines has been a prime example, with current estimates forecasting $3.8 billion in 2014 earnings, compared with last year's $1.95 billion in earnings from American Airlines and US Airways.
Much of this trend can be attributed to disciplined capacity management that has kept fares at higher margin levels, in contrast with past examples of margin-destroying fare wars.
Not only is this profit growth good for justifying a higher current price, but 2014 profit growth also keeps a multi-year trend of airline profit growth alive. The airline bull thesis centers on the argument that, thanks to better management and industry consolidation, the industry will no longer be the competitive cutthroat environment it used to be and will instead see strong profit growth through improved demand and higher margins.
The 2014 profit growth keeps the trend going that saw significant year-over-year profit growth for the past few years, with estimates calling for further increases for 2015 and 2016.
The bottom line
American Airlines has come a long way since its 2011 bankruptcy to become one of the best performing airline stocks of 2014, thanks to rising earnings estimates, higher profits, and the expectation and confirmation of share buybacks and dividends.
The company still has the challenge of bringing together American Airlines and US Airways, with integration issues serving as a risk going forward. However, if management can pull it off with minimal turbulence, American Airlines Group could be set for more gains over the next couple of years.