AMR: Negativities baked into the share price.

American Airline (AMR) has seen huge selling pressure in recent weeks. When Dow is hitting all time high level every other day, seeing its share plunge by more than 30% from the high achieved in early Feb (low $40) has frustrated many long term share holders. FilthyRich hive initiated AMR into our core holding last Nov at the price of around $32 a share. The shares soon hit low $40 level in matter of a few months but since Feb of this year, share price has seen steady and at times fast decline to reach today closing price just below $27 level.

I believe current share price is a great buying opportunity. I believe patient investors could see the stock double from this level and I think current share price represents a great entry price for risk tolerant investors.

Let us look at what has been pressuring AMR to the downside. Single most important negative catalyst for the stock is the high fuel price (refined oil). Crude oil was trading at high $40 range in the beginning of this year. However, the crude has gone upto $65 to $66 level today. To make the problem worse, the refining capacity of the crude oil is undergoing temporary reduction due to several outages at various refinery locations. Political uncertainty surrounding Iran, Nigeria, and Venezuela is creating perception that crude oil supply will remain tight. In addition, with summer driving season approaching, oil traders are betting the price higher. Second negative catalyst is coming from Delta Air that will exit its bankruptcy this Thursday. Delta's exit from bankruptcy is seen to increase supply of airline stocks for the investors. Finally the economy is seen to slow down, reducing prospect of airline traffic among retail and business travelers. In summary, higher fuel price, slowing economy that leads to lower air traffic, and increased number of airline stocks are decreasing investor appetite for AMR shares. Multiple downgrades from analysts have occurred this week. With these events behind us, I believe AMR current share price has effectively is accounting for most of the negativity and downside is limited due to very low PE valuations.

So why am I bullish on AMR? I believe that high oil price is temporary and will come to level below $60 after the summer driving season. The fact is that oil inventory has been increasing (we will hear more on this tomorrow). Refining capacity shortage is short term in nature and is likely to abate after the summer driving season. If the economy is truly slowing as bears contend, then demand for oil is likely to be lower. It is granted that oil price this year has been a lot higher than my expectation. I expected that the oil would stay in the range between $45 to $55 in 07. But it is looking more likely to be in-between $55 and $65 but AMR can still make a plenty of profit even at these oil prices.

Economy is slowing but I expect slowdown will be gradual, still supporting healthy airline traffic volume. Housing and auto sectors will likely to show weakness for prolonged period. But the employment and industrial data looks still reasonably good. In addition, wage picture continues to look benign, supporting reasonable consumer spending pattern. Airline traffic volume will look reasonable as the economy will achieve soft-landing. While domestic air traffic may stall, international traffic could deliver healthy surprises. Weak dollar could encourage more foreign people traveling into the US and recent open sky pact between the US and Europe could spur healthy traffic volume for AMR in 07 and 08. Furthermore, 08 Chinese Olympic can also be a huge travel volume boost for AMR as it is likely to lead to increased travel volume among business travelers.

The fact of the matter is AMR continues to improve its operational efficiency. It is upgrading its plane fleet to new Boeing 737 from old MD-80 with the money raised from secondary offering in early this year. The cost saving initiatives are making the company lean and mean for generating nice cash flow from the operation. In fact, the company has cut its debt level by 2 billion to $17.5 billion. This reduction in debt level is likely to accelerate in 07 as the company now has the better cash generation model after so much business streamlining efforts.

Last April, the company has reported quarterly profit of 30 cents. This was first quarterly profit in 7 years. The company also hedged its 34% of fuel need for 07 at $65 and 27% of the fuel need at $63. According to some analysts estimate, AMR EPS estimate is seen to be about $4.5 with fuel price trading around mid $60 level. Should this oil price dip to low 60 to high 50 level, the EPS estimate can be hiked to $5.5 level. If more aggressive increase in RASM ( revenue per available seat miles) applied with oil price in the range of low $50, then EPS could skyrocket to the level exceeding $8 level.

Thus, AMR is trading with very low valuation. It is currently trading with PE of 6 based on 07 EPS estimate and lower than 5 on 08 estimate. Should more favorable oil price is seen towards late this year, this multiple could expand to 10, causing the share price to trade well above $55 level. I see possibly another 10% downside but see more than 100% upside. This is definitely favorable risk to award ratio.

In summary, AMR shares took most of the negativities into the share price and it represents great buying opportunity at the current price. I would be an aggressive buyer of the AMR share. Last week, I took some call option positions to reflect my belief that AMR stock has seen the bottom although recovery may not fast until investors become more confident that the economy is not heading into recession and the oil price will not skyrocket above $80 level.


The current stocks in that I cover are: Filthy Rich Tech ideas (comprised of Openwave, Avid Technology, Tivo, IBM, and Research in Motion), Filthy Rich Biotech ideas (comprised of Amgen, Celgene, Genzyme, Isis pharmaceuticals, Alnylam pharmaceutical, and Protein Design Lab), Filthy Rich Financial ideas (JP Morgan and Goldman Sachs), Filthy Rich China ideas (Focus Media Holding and Ctrip.com), Filthy Rich Transportation ideas ( American Airline and Southwest Airline), and Filthy Rich Specialty Retail ideas (Peet's coffee)

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