American’s valuation based on EV/EBIDAR multiple

Market Realist

American Airlines Group - Second quarter earnings overview (Part 11 of 11)

(Continued from Part 10)

The commonly used valuation multiple to analyze if the company stock is undervalued or overvalued is EV/EBITDA. This multiple is based on the Enterprise value (EV) which is defined as the theoretical takeover price and is calculated as Market capitalization plus net debt and minority interest. EV/EBITDA therefore represents the price paid per dollar of EBITDA. A lower than industry average EV/EBITDA multiple implies that the company is undervalued. The advantage of this multiple over the Price to earnings multiple, another widely used valuation metric is that is it neutral to capital structure. Hence it makes it possible to compare companies with different levels of debt.

  Since airline companies are generally characterized by high levels of debt and leases on aircrafts, along with debt, lease rentals also have to be adjusted to compare airlines with different aircraft ownership structures. Hence EV/EBITDAR multiple (where EBITDAR is Earnings Before Interest, D&A and Rent) is more appropriate for airline companies. American (AAL) is undervalued compared to most of its peers since its forward EV/EBITDAR multiple is 5.91, lower than Delta (DAL), United (UAL) and Southwest (LUV). JetBlue’s (JBLU) multiple of 5.57 is slightly lower than American. However its high leverage and increasing cost structure may hinder its performance if economic conditions turn unfavorable. After the merger, American is now the largest airline in U.S. by available seat miles (ASM). The company’s confidence in its future growth is reflected in its plan to declare dividend for the first time since 1980 and also the $1 billion share repurchase program. From the date of closure of the merger (i.e. December 9 th 2014) with U.S. Airways share prices have increased by 55% to $38.12.    

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