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American Airlines Group Inc.'s (NASDAQ:AAL) Intrinsic Value Is Potentially 43% Above Its Share Price

Key Insights

  • The projected fair value for American Airlines Group is US$19.10 based on 2 Stage Free Cash Flow to Equity

  • American Airlines Group's US$13.35 share price signals that it might be 30% undervalued

  • Analyst price target for AAL is US$14.24 which is 25% below our fair value estimate

How far off is American Airlines Group Inc. (NASDAQ:AAL) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by taking the forecast future cash flows of the company and discounting them back to today's value. This will be done using the Discounted Cash Flow (DCF) model. There's really not all that much to it, even though it might appear quite complex.

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. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

See our latest analysis for American Airlines Group

Is American Airlines Group Fairly Valued?

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 start off with, we need to estimate 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.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, so we need to discount the sum of these future cash flows to arrive at a present value estimate:

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$13.4, the company appears quite undervalued at a 30% discount to where the stock price trades currently. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind.

dcf
dcf

Important Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. Part of investing is coming up with your own evaluation of a company's future performance, so try the calculation yourself and check your own assumptions. 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.

Next Steps:

Whilst important, the DCF calculation shouldn't be the only metric you look at when researching a company. DCF models are not the be-all and end-all of investment valuation. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. Why is the intrinsic value higher than the current share price? For American Airlines Group, we've compiled three further factors you should explore:

  1. Risks: Consider for instance, the ever-present spectre of investment risk. We've identified 3 warning signs with American Airlines Group (at least 2 which are a bit unpleasant) , and understanding them should be part of your investment process.

  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. Simply Wall St updates its DCF calculation for every American stock every day, so if you want to find the intrinsic value of any other stock just search here.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.

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