American Airlines Stock Could Rise Another 20%

American Airlines stock (AAL) is still 10% to 20% undervalued despite a recent rise, according to James Dondero, President and co-founder of Highland Capital Management, which together with its affiliates advises approximately $20 billion.

“The impact of lower fuel costs due to the recent drop in crude prices is worth at least $2 to $3 a share to American earnings,” Dondero said. “That’s huge when you consider that the company is expected to earn about $6 in 2014 but on pace to earn over $10 in the next 12 months.”

That, combined with the relative affordability of airfares and a diminished potential for re-regulation, means American stock should be trading at a significant premium to its current price at around $50 a share.

“It should be a $55 to $60 stock -- at least,” Dondero said. “The only thing that scared it into the $40s was fear over PRASM declines resulting from lower fuel prices.  However, demand remains relatively strong domestically, a region where American operates a relatively larger amount of its capacity versus Delta and United.”

JP Morgan recently cited some of the same factors in a research note arguing for a 60% increase in the share prices of the “Big Three” airlines.

Dondero said airfares remain historically low, adjusted for inflation, even after recent, system-wide fare increases. The average domestic airfare is 14% lower today than it was in 1995, he said.

Airlines, especially American, have become much more disciplined in the management of capacity, upgrading equipment on routes that support the investment but refraining from major capacity increases.

Dondero took a big position in AAL when the merger with US Airways was still uncertain and doubt surrounded the American management team. Highland and its affiliate advised accounts own over 8 million shares – a nearly $425 million stake.