Is AMR's Equity Practically Worthless?
publication date: May 19, 2011
author/source: Brian Nelson, CFA
This article originally appeared on Seeking Alpha. Please view disclosures: https://seekingalpha.com/article/270933-is-amrs-equity-practically-worthless
As outlined in "Why Airline Stocks Are Not Long-Term Investments," pegging a fair value on an airline's equity is a nearly impossible task due to the tremendous operating leverage inherent to their business models and the fact that key valuation drivers such as unit revenue and unit cost are largely out of their control. That said, let's take a look at what AMR's equity investors have to overcome to recognize any value in their holdings.
What does all of this mean? Essentially, in order for AMR's equity to be worth anything, the firm would need to generate a discounted enterprise free cash flow stream (i.e. free cash flow to the firm) that amounts to more than $41 per share (or about $13.7 billion).
The firm's federal net operating losses of approximately $6.7 billion and state net operating losses of $3.7 billion should allow it to avoid paying taxes for many years to come. Since these tax benefits have been in place for some time, it may be relatively straightforward to use the mid-cycle estimate of $648 million in enterprise cash flow (see above), which notably includes the boom years of 2006 and 2007 when WTI crude prices were $66 and $72, respectively, well below today's levels.
If we value AMR's operating assets through a standard mid-cycle perpetuity function, we're looking at about $6 billion to $7 billion in value (assuming a very generous 10% discount rate, given AMR's risk profile) -- not even close to the $13.7 billion equity investors need to break even.
Admittedly, there's always option value in companies like AMR should mid-cycle performance in the industry be raised considerably. For example, if crude oil prices fell below $70 permanently and global economic growth resumed the pre-Great Recession levels, AMR could see its stock pop to over $20 per share, assuming peak cash-flow assumptions are now the new norm for the company and industry.
Needless to say, this is a very unlikely scenario, and modeling peak assumptions into perpetuity for an extremely cyclical industry is a classic no-no in estimating long-term intrinsic value. And while a sum-of-the-parts analysis for AMR (breaking apart Eagle, its frequent-flyer program) may suggest even higher valuations, especially during optimistic times, we caution investors that breaking apart an entity does little to alter the underlying long-term, cash-flow dynamics of the components of that entity.
AMR's equity is not worth $0 per share given the concept of option value. But with a break-even, mid-cycle enterprise free cash flow number that's north of about $1.4 billion (assuming very generous discount rates, given its competitive position and well-documented risks of the airline industry), AMR has some work to do to deliver any value to shareholders.
Disclosures: Brian Nelson owns put options on AMR at the time of this writing.