The ongoing power struggles in Middle East comprises the latest one being the standoff between Saudi Arabia and Yemen Shia rebels. The latest geopolitical scuffle in the Middle East has given rise to speculative oil prices, with the fear of a possible shortage of oil. Millions of barrels pass through the 18-mile Bab el-Mandeb point which lies between Yemen and Djibouti separating the Gulf of Aden from the Red Sea and the Suez Canal. By the end of the trading season on March 26, this reflected on the recovery shown by the oil sector. The trading hours saw the industry standard Brent crude oil, due for delivery in the month of April, rise by 4.46% to close at $59 per barrel and the West Texas crude gained 4.19% to close at $51.27 a barrel. Experts believe that this knee jerk reaction may have a temporary effect on oil prices; as Saudi Arabian, Nigerian and Mexican oil is waiting to hit the U.S. shores.
Cascading effect
Airlines industry fortunes are directly dependent on the existing oil prices. A rise in oil prices means a drop in their operating margins and overhead costs. One particular airline which seems to have immediately been got caught in the crossfire is the American Airlines Group Inc. (AAL, Financial). By the end of the trading season on March 26, 2015, the shares closed 1.43% lower at $51.26.
Inverse relationship between oil and airlines industry
The airlines industry, which was struggling for survival until the early quarters of last year, has benefited tremendously from the fall in oil prices. Many global carriers have seen their numbers and ratings move from the red to green zone. Since the beginning of 2014, Delta Airlines Inc. (DAL, Financial), Jet Blue Airways Corporation (JBLU, Financial), Southwest Airlines Co. (LUV, Financial) saw their stock prices climb by 77.58%, 84.42% and 124.2%, respectively. American Airlines' share price rose by 111.5% during the same period. But it cannot be denied that the industry continues to face headwinds, especially in the wake of unstable oil prices and dollar movement against global currencies.
Analysts are hopeful on the AAL stock. "The Street" has rated American Airlines at a "C" rating (hold). S&P Capital IQ initiated the stock quote with a "Buy" rating. Stifel Financial Corporation (SF, Financial) has put the stock in the "Buy" category. A careful study of the stock reveals the optimism and neutrality in the analyst ratings.
Financial equations are vital assessment tools
The stock has some positives and some negatives. A strong equity position in the balance sheet can be counted as a positive. The annualized returns on equity of American Airlines for the quarter that ended December 2014 was 68.31%. Another positive is the revenue growth of 38.5% in the recent quarter which is above the industry standard of 22.1%. The positive revenue growth has trickled down to the EPS which stands at $3.93 per share for the full year. The net profit margin of 5.87% is also higher than the industry average.
The negative points include the present gross profit margin of 32.26% which is higher than the corresponding period of last year but continues to remain below the industry average. The net operating cash flow has shown a stupendous increase of 171.27% at $804 million compared to the corresponding quarter of last year, but it is much lower than the industry average of 1559%. The debt equity ratio is higher than the industry average of 8.86 indicating risk of debt management getting out of control.
In December 2013, the merger of American Airlines and US Airways took place. In an employee newsletter released on March 25, the company announced that it is expecting to receive a Single Operating Certificate (SOC) from the regulators on April 8, 2015. The certificate will enable the merged entity to be recognized as one by the Federal Aviation Administration. Although complete integration will take some more time, on the back end the process of integrating the loyalty program for frequent fliers is already under way and expected to be completed within a few days.
Conclusion
American Airlines continues to provide a good return on equity and showcases solid revenue growth. The stock has also risen pretty well during the past year. The oil price is currently in a volatile state and has the possibility of heading either way. But if experts are to be believed, then it will take a long time for the oversupply situation to correct itself. Hence the airlines industry has some more time to breathe easy. Despite the recent knee jerk reaction to the rise in oil prices, it is a safe bet to "Hold" on to the stock.
