UBS: We're 'Optimistic' On American Airlines, But See Downside Risk To Q3 Numbers

In a report published Thursday, UBS analyst Darryl Genovesi maintained a Neutral rating and $43 price target on American Airlines Group Inc AAL. "We are increasingly optimistic as integration remains on track and competitive growth appears likely to slow by year-end while FCF should improve as capex declines and we think this can drive multiple-expansion. However, we see downside risk to Q3 consensus expectations and would wait for initial Q3 guidance in mid-July before getting involved," Genovesi stated. American Airlines' management believes that while demand trends appear to be flat year-on-year, domestic capacity growth in the mid-single digits would be challenging. The management also acknowledged that it would need to aggressively match competitor fares. According to the UBS report, "AAL sees demand as inelastic and believes a hypothetical 1 percent industry-wide capacity cut would drive ~0.5 percent industry-wide revenue growth on ~1.5 percent PRASM growth. This is consistent with IATA's -0.6x price elasticity measurement from 2007." The company intends to retire its MD-80s over the coming two years, while deferring the delivery of 35 A321neos, which is leading to net capacity reduction. Mainline aircraft deliveries are expected to decline from about 80 per year in 2014-2015 to about 60 per year during 2016-2018. This is turn is likely to lead to aircraft capex decline of about $1 billion. "While AAL is taking some competitive action, we think this is marginal as management also stated unequivocally that it believes unit revenue (PRASM) needs to grow regardless of fuel price," Genovesi added.