Shares of American Airlines Group (NASDAQ:AAL) are up over 50% this year following the merger of American Airlines and US Airways late last year. But even with these gains, the stock still looks reasonably priced and has a few big factors that could drive shares higher over the next couple of years.
With the market near all-time highs, it's tough for many investors to find stocks with attractive valuations. But even after the gains over the past several months, American Airlines Group shares still trade at only seven times forward earnings.
If American Airlines Group shares traded at the S&P average of 16.7 times forward earnings, they would be going for over $90 each. While the higher risk nature of the airline industry and American Airlines Group's status as a mature company will probably keep investors from assigning the airline such a generous multiple, a valuation of 10 times earnings still values shares at $55 each, about 44% higher than current levels.
At 10 times earnings, American Airlines Group would still carry a lower valuation than the industry average and well below that of the broader market. Keep in mind that this airline is also on track to continue growing earnings, with analysts reporting to Nasdaq forecasting earnings to rise another 60% by 2017.
While you should always take analyst estimates with a grain of salt, the airline has a history of meeting estimates and appears well on track to meet this year's estimates as well.
With American Airlines Group putting together the world's largest airline, it would make sense for its shares to be a core part of institutional airline investment portfolios. In addition, the lower valuation of the stock makes it appealing compared with the average industry valuation.
Yet Reuters data shows that American Airlines Group has institutional ownership of 71%, well below Southwest Airlines at 81% and Delta Air Lines at 86%. This discrepancy may be due to institutions that are easing into the stock or waiting for integration risks to die down. But there is another possible explanation.
Although its current profits may make it seem otherwise, American Airlines only emerged from bankruptcy last December, when it officially merged with US Airways and formed the American Airlines Group that exists today.
This isn't that big a deal for ordinary investors, but it can make buying more difficult for certain institutions. To control risks, many institutions have extra rules such as minimum stock price and market capitalization rules. In this case, some institutions may not be able to buy shares until one year after American Airlines has emerged from bankruptcy. After Dec. 9 of this year, investors will get a better feel for how much buying pressure this could add to the stock.
Integration risk reduction
American Airlines and US Airways officially merged last December, but there is still a lot to stitch together. From combining technical systems to labor issues, many investors are rightly factoring integration risk into their calculations.
This is not surprising, given the turbulence in the United Continental merger and the large number of parties involved in labor negotiations. While integration risks still exist, if this merger can be managed better than United Continental's merger, investors previously fearful of these risks may begin adding American Airlines Group shares to their portfolios.
Current investors should not ignore integration risks, but a successful integration could serve as a multi-year catalyst for this airline's shares.
American Airlines Group has posted big gains so far this year, but there is a lot more room to fly if the airline can live up to expectations. With a low valuation and the potential for more institutional buying, these shares are worth a look for risk-tolerant value investors.
Alexander MacLennan owns shares of American Airlines Group, Delta Air Lines, and Tesla Motors and has options on American Airlines Group and Delta Air Lines. The Motley Fool recommends and owns shares of Ford and Tesla Motors. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.