Stock Analysis

Is There An Opportunity With American Airlines Group Inc.'s (NASDAQ:AAL) 36% Undervaluation?

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NasdaqGS:AAL
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Key Insights

  • American Airlines Group's estimated fair value is US$19.10 based on 2 Stage Free Cash Flow to Equity
  • American Airlines Group is estimated to be 36% undervalued based on current share price of US$12.23
  • Our fair value estimate is 34% higher than American Airlines Group's analyst price target of US$14.24

Does the November share price for American Airlines Group Inc. (NASDAQ:AAL) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by estimating the company's future cash flows and discounting them to their present value. Our analysis will employ the Discounted Cash Flow (DCF) model. It may sound complicated, but actually it is quite simple!

We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.

Check out our latest analysis for American Airlines Group

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. To begin with, we have to get estimates of the next ten years of cash flows. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.

Generally we assume that a dollar today is more valuable than a dollar in the future, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) estimate

2024 2025 2026 2027 2028 2029 2030 2031 2032 2033
Levered FCF ($, Millions) US$1.02b US$1.91b US$1.65b US$1.50b US$1.42b US$1.38b US$1.35b US$1.35b US$1.35b US$1.37b
Growth Rate Estimate Source Analyst x2 Analyst x3 Est @ -13.55% Est @ -8.82% Est @ -5.51% Est @ -3.19% Est @ -1.57% Est @ -0.43% Est @ 0.36% Est @ 0.92%
Present Value ($, Millions) Discounted @ 12% US$908 US$1.5k US$1.2k US$948 US$798 US$689 US$604 US$536 US$479 US$431

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$8.1b

The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 2.2%. We discount the terminal cash flows to today's value at a cost of equity of 12%.

Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US$1.4b× (1 + 2.2%) ÷ (12%– 2.2%) = US$14b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$14b÷ ( 1 + 12%)10= US$4.4b

The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is US$12b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of US$12.2, the company appears quite undervalued at a 36% discount to where the stock price trades currently. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.

dcf
NasdaqGS:AAL Discounted Cash Flow November 30th 2023

Important Assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. You don't have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. The DCF also does not consider the possible cyclicality of an industry, or a company's future capital requirements, so it does not give a full picture of a company's potential performance. Given that 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 weighted average cost of capital, WACC) which accounts for debt. In this calculation we've used 12%, which is based on a levered beta of 2.000. Beta is a measure of a stock's volatility, compared to the market as a whole. We get our beta from the industry average beta of globally comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.

SWOT Analysis for American Airlines Group

Strength
  • Debt is well covered by earnings.
Weakness
  • No major weaknesses identified for AAL.
Opportunity
  • Annual earnings are forecast to grow faster than the American market.
  • Good value based on P/E ratio and estimated fair value.
Threat
  • Debt is not well covered by operating cash flow.
  • Total liabilities exceed total assets, which raises the risk of financial distress.
  • Annual revenue is forecast to grow slower than the American market.

Looking Ahead:

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. The DCF model is not a perfect stock valuation tool. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. Why is the intrinsic value higher than the current share price? For American Airlines Group, we've put together three additional factors you should look at:

  1. Risks: For instance, we've identified 3 warning signs for American Airlines Group (2 are a bit unpleasant) you should be aware of.
  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: Do you like a good all-rounder? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!

PS. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the NASDAQGS every day. If you want to find the calculation for other stocks just search here.

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