# An Intrinsic Calculation For American Airlines Group Inc (NASDAQ:AAL) Shows It’s 36.44% Undervalued

How far off is American Airlines Group Inc (NASDAQ:AAL) from its intrinsic value? Using the most recent financial data, I am going to take a look at whether the stock is fairly priced by taking the foreast future cash flows of the company and discounting them back to today’s value. I will use the discounted cash flows (DCF) model. Don’t get put off by the jargon, the math behind it is actually quite straightforward. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model. Please also note that this article was written in June 2018 so be sure check out the updated calculation by following the link below.

### Step by step through the calculation

We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second ‘steady growth’ period. In the first stage we need to estimate the cash flows to the business over the next five years. Where possible I use analyst estimates, but when these aren’t available I have extrapolated the previous free cash flow (FCF) from the year before. For this growth rate I used the average annual growth rate over the past five years, but capped at a reasonable level. I then discount the sum of these cash flows to arrive at a present value estimate.

#### 5-year cash flow forecast

 2018 2019 2020 2021 2022 Levered FCF (\$, Millions) \$1.84k \$1.40k \$2.69k \$2.90k \$3.13k Source Analyst x2 Analyst x3 Analyst x1 Extrapolated @ (8%) Extrapolated @ (8%) Present Value Discounted @ 11.43% \$1.65k \$1.12k \$1.94k \$1.88k \$1.82k

Present Value of 5-year Cash Flow (PVCF)= US\$8.42b

We now need to calculate the Terminal Value, which accounts for all the future cash flows after the five years. The Gordon Growth formula is used to calculate Terminal Value at an annual growth rate equal to the 10-year government bond rate of 2.9%. We discount this to today’s value at a cost of equity of 11.4%.

Terminal Value (TV) = FCF2022 × (1 + g) ÷ (r – g) = US\$3.13b × (1 + 2.9%) ÷ (11.4% – 2.9%) = US\$38.05b

Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = US\$38.05b ÷ ( 1 + 11.4%)5 = US\$22.15b

The total value is the sum of cash flows for the next five years and the discounted terminal value, which results in the Total Equity Value, which in this case is US\$30.57b. To get the intrinsic value per share, we divide this by the total number of shares outstanding, or the equivalent number if this is a depositary receipt or ADR. This results in an intrinsic value of \$65.31. Compared to the current share price of \$41.51, the stock is quite good value at a 36.44% discount to what it is available for right now.

### The assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. If you don’t agree with my result, have a go at the calculation yourself and play with the assumptions. Because we are looking at American Airlines Group as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighed average cost of capital, WACC) which accounts for debt. In this calculation I’ve used 11.4%, which is based on a levered beta of 1.203. This is derived from the Bottom-Up Beta method based on comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.

### Next Steps:

Valuation is only one side of the coin in terms of building your investment thesis, and it shouldn’t be the only metric you look at when researching a company. What is the reason for the share price to differ from the intrinsic value? For AAL, I’ve put together three fundamental factors you should look at:

1. Financial Health: Does AAL have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
2. Future Earnings: How does AAL’s growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.
3. Other High Quality Alternatives: Are there other high quality stocks you could be holding instead of AAL? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!

PS. Simply Wall St does a DCF calculation for every US stock every 6 hours, so if you want to find the intrinsic value of any other stock just search here.