American Airlines (AAL): Are Hedge Funds Right About This Stock?

US Airways acquired American Airlines in December 2013 and took its name. We first recommended this stock at the end of August 2012 when it was trading at $10 per share. It briefly dropped off of our list in November 2012, but we got back in American Airlines Group Inc (NASDAQ:AAL)  in February 2013 when it was trading below $15. With the U.S. economy healthy, the long thesis that American Airlines is a leader in an economically sensitive industry still holds.

Developments/ Catalysts:

American Airlines Group Inc (NASDAQ:AAL) reported first quarter earnings of $1.25 per share on revenue of $9.44 billion. Earnings were lower than in the first quarter of last year because the company’s profits were taxed at 38% versus 0% for last year. When removing the effect of the added taxes, American Airlines’ adjusted earnings per diluted share rose 15 percent.

Despite the stronger operational results, American Airlines’ stock has retreated for several reasons. First, given that crude prices have risen over 70% from their February lows, low crude prices aren’t guaranteed to be a tailwind anymore. Second, industry capacity has expanded faster than GDP, with American Airlines’ consolidated passenger revenue per ASM (PRASM) falling 7.5% year-over-year and consolidated passenger yield declining 7.1%. The major airlines ran into trouble in the previous cycle by expanding capacity too much during the good times, only to report sharp losses when the business cycle turned. Investors are afraid that a replay of the previous cycle could occur. Third, the company’s labor costs has risen. To retain talent, management instituted a new employee profit sharing program that will pay 5 percent of pre-tax profit excluding special items. The profit sharing lowers the total benefit to American Airline shareholders.

While American Airlines Group Inc (NASDAQ:AAL) looks very cheap based on its forward earnings P/E of 5.22, its earnings are overstated because it is making lots of investments that it should have made years ago. AAL spent $5.3 billion on new aircrafts in 2015, and plans to invest $4.5 billion on new aircraft in each of 2016 and 2017. Because only part of that capital investment shows up as annual depreciation in AAL’s financial statements, its EPS overstate its true earnings.

Hedge funds are long AAL, however, because the stock is a value play and the company is returning capital to shareholders. American Airline’s capital returned $1.6 billion to stockholders through share repurchases and dividends in the first quarter and the company’s board authorized an additional buyback of $2 billion. American Airlines Group Inc (NASDAQ:AAL)’s large capital investments today will help it in the long run too. Because it has one of the youngest fleets in the industry, AAL will have lower costs and more cash flow in the future for buybacks and dividends.

Earlier this month, John Lykouretzos of Hoplite Capital Management participated in the Skybridge Alternatives Conference in Las Vegas and said that Hoplite is shorting American Airlines Group Inc (NASDAQ:AAL)’s stock because the investor believes that the company has high costs. Hoplite added that it plans for the bet to pay off in the next 18 to 36 months, as American Airlines Group has a high exposure to rising oil prices and has the highest leverage. However, many investors are still long American Airlines Group and on the following page, we are going to take a closer look at the hedge fund sentiment surrounding the stock.

American Airlines Group Inc (NASDAQ:AAL) was in 61 hedge funds’ portfolios at the end of March. AAL has experienced a decrease in support from the world’s most elite money managers of late. There were 76 hedge funds in our database with AAL positions at the end of the previous quarter. The level and the change in hedge fund popularity aren’t the only variables you need to analyze to decipher hedge funds’ perspectives. A stock may witness a boost in popularity, but it may still be less popular than similarly priced stocks. That’s why at the end of this article we will examine companies such as Health Care REIT, Inc. (NYSE:HCN), Dollar General Corp. (NYSE:DG), and Deere & Company (NYSE:DE) to gather more data points.

In the eyes of most shareholders, hedge funds are perceived as unimportant, old investment tools of yesteryear. While there are more than 8000 funds in operation at present, Our researchers hone in on the top tier of this club, approximately 700 funds. Most estimates calculate that this group of people orchestrate most of all hedge funds’ total capital, and by keeping an eye on their first-class equity investments, Insider Monkey has come up with a few investment strategies that have historically beaten Mr. Market. Insider Monkey’s small-cap hedge fund strategy outperformed the S&P 500 index by 12 percentage points per year for a decade in their back tests.

Now, we’re going to go over the latest action encompassing American Airlines Group Inc (NASDAQ:AAL).

What does the smart money think about American Airlines Group Inc (NASDAQ:AAL)?

Heading into the second quarter of 2016, a total of 61 of the hedge funds tracked by Insider Monkey were bullish on this stock, a change of -20% from the fourth quarter of 2015. With the smart money’s positions undergoing their usual ebb and flow, there exists a few noteworthy hedge fund managers who were increasing their stakes significantly (or already accumulated large positions).

According to Insider Monkey’s hedge fund database, Ross Margolies’s Stelliam Investment Management has the most valuable position in American Airlines Group Inc (NASDAQ:AAL), worth close to $191 million, corresponding to 5.9% of its total 13F portfolio. On Stelliam Investment Management’s heels is Highland Capital Management, led by James Dondero, holding a $131.2 million call position; the fund has 5.8% of its 13F portfolio invested in the stock. Some other peers that hold long positions encompass James Dondero’s Highland Capital Management, and Phill Gross and Robert Atchinson’s Adage Capital Management.

Due to the fact that American Airlines Group Inc (NASDAQ:AAL) has experienced a decline in interest from the aggregate hedge fund industry, it’s easy to see that there lies a certain “tier” of fund managers that slashed their positions entirely in the first quarter. Intriguingly, James Dinan’s York Capital Management said goodbye to the largest investment of all the hedgies monitored by Insider Monkey, comprising about $94.6 million in stock, and Zac Hirzel’s Hirzel Capital Management was right behind this move, as the fund dropped about $71.5 million worth. These transactions are intriguing to say the least, as aggregate hedge fund interest dropped by 15 funds between January and March.

Let’s go over hedge fund activity in other stocks – not necessarily in the same industry as American Airlines Group Inc (NASDAQ:AAL) but similarly valued. We will take a look at Health Care REIT, Inc. (NYSE:HCN), Dollar General Corp. (NYSE:DG), Deere & Company (NYSE:DE), and Tyson Foods, Inc. (NYSE:TSN). This group of stocks’ market values match AAL’s market value.

As you can see these stocks had an average of 36 hedge funds with bullish positions and the average amount invested in these stocks was $1.82 billion. That figure was $1.50 billion in AAL’s case. Dollar General Corp. (NYSE:DG) is the most popular stock in this table. On the other hand Health Care REIT, Inc. (NYSE:HCN) is the least popular one with only 21 bullish hedge fund positions. Compared to these stocks American Airlines Group Inc (NASDAQ:AAL) is more popular among hedge funds. Considering that hedge funds are fond of this stock in relation to its market cap peers, it may be a good idea to analyze it in detail and potentially include it in your portfolio.

Disclosure: none