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Wait for Another Pullback Before Buying American Airlines

I don’t have to tell how bad the novel coronavirus pandemic has been for American Airlines (NASDAQ:AAL). Since the outbreak first hit China, AAL stock has cratered from around $30 per share to under $10 per share. But, could a low share price mean a solid “bottom-fishing” opportunity?

It depends. Shares today may look ripe as a contrarian buy, but keep in mind the many fleas on this legacy carrier. Even before the pandemic affected air travel.

As I previously discussed, American Airlines already had a heavy debt load and other operating issues.

And despite the company receiving $5.8 billion in payroll support from the recent $2 trillion CARES Act stimulus package, they could burn through billions more as the airline industry remains effectively grounded.

The worst of the coronavirus in America may already be over. But, it could be years before airline stocks like American start rebounding again. With this in mind, today’s prices may not be enough to justify a buy in the near-term.

Yet, that doesn’t completely rule out American Airlines as a buy at lower prices. Let’s dive in, and see why a “wait-and-see” approach may be the best way to play this hard-hit airline stock.

Slow Recovery Means More Bad News for AAL Stock

Things may be starting to “return to normal.” But, don’t take that to mean smooth sailing ahead for the U.S. economy. The damage caused by the pandemic and its associated shutdowns could linger on throughout the year. And that’s especially the case for the airline industry.

There are many reasons why the stimulus package is far from being a “silver bullet” for American and the other airlines. Firstly, airlines have many other fixed costs they need to cover, not just payroll. Secondly, it doesn’t matter how much money the U.S. Treasury throws at the airline industry: the main issue is sustained declines in passenger traffic.

As this Barron’s article recently discussed, American Airlines plans to run flights at half-capacity in order to ensure passenger safety. This may be an improvement from the 90% year-over-year declines in air travel compared to last year. But it does highlight how air traffic could remain far below the high water mark, even after the pandemic is in the rearview mirror.

If the air travel market remains depressed, what’s to say the airlines won’t need CARES Act 2.0? With these concerns top of mind, it’s tough to be confident in the near-term prospects for American.

Darkest Before the Dawn?

Things sound bleak for American Airlines. Yet, with the share price falling below $10 per share, the stock could be bottoming out. Buying while the stimulus package was underway in late March would have been a terrible time to enter a position. The stock soared from around $10 per share to prices above $16 per share. At that price level, the risk/return proposition is not in your favor.

But, if shares retest prices in the single-digits, the odds are on your side. As InvestorPlace’s Tom Taulli wrote last month, it’s likely American Airlines survives coronavirus. Granted, this doesn’t guarantee shares won’t head lower from where they are now.

Yet, with the potential for big gains in the next few years if air travel rebounds quicker than anticipated, shares could be a strong buy at a lower valuation. In short, don’t chase this stock if enthusiasm sends it higher on a breadcrumb of good news. Instead, consider shares a buy if additional negative developments push shares to even lower prices.

Wait-and-See Is the Key With AAL Stock

When I last wrote about American Airlines stock, I said it was too early to buy but too late to go short. I stand behind this take. Warren Buffett may have recently sold his airline stocks. But, the risk of shares rallying on better-than-expected data makes it tough to bet this stock heads below the most bearish of price targets.

Nevertheless, don’t see this to mean, “go buy American, pronto.” As I mentioned above, air travel could remain depressed for several years.

Yet, large-scale bankruptcies are the last thing the current administration wants. Especially in a re-election year. With this in mind, the downside may be lower than one would expect for a hard-hit sector like airlines.

Bottom line: wait for American Airlines shares to head lower before entering a position. At prices between $5 and $10 per share, the potential price appreciation more than makes up for the risk.

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