Airline stocks are about to take a breather after taking flight in fourth quarter
After strong fourth-quarter gains, U.S. airline stocks are likely to take a breather in the near term, as investor attention shifts toward rising costs and away from improving revenue trends, Cowen & Co. said Wednesday.
Analysts said they are taking a more defensive stance on the sector heading into 2017, as they downgraded six stocks, including American Airlines Group Inc. AAL, +1.38% and United Continental Holdings Inc. UAL, +1.07% . Gains made after the November presidential election on improving demand and yields were mostly due to price-to-earnings multiple expansion, meaning improved expectations for the sector, and not due to fundamentals, said Cowen analysts, led by Helane Becker.
‘We do not believe this is the end of the airline cycle. We believe with the recent positive trend in the shares and subsequent upward multiple moves the group is due for a break.’
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Airline shares gained about 29% in the fourth quarter, while valuation multiples for the sector climbed 37%.
“We do not believe this is the end of the airline cycle,” she wrote. “We believe with the recent positive trend in the shares and subsequent upward multiple moves the group is due for a break.”
Investor expectations for the sector are elevated, she wrote. Delta Air Lines Inc. DAL, +2.80% has guided analysts toward flat unit revenue for the first quarter, and investors, Becker said, should expect that to be the case for the rest of the industry.
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“We expect investors will look for the next issue to nitpick,” she said. “We believe that issue will be margin compression due to higher jet-fuel and labor costs. If we were to couple recent multiple expansion with our view of margin compression, and a potential stumble on unit revenue, we believe there is more downside than upside over the next six months.”
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Cowen downgraded the stock of American Airlines, Air Canada AC, -0.94% , Alaska Air Group Inc. ALK, +1.53% , JetBlue Inc. JBLU, +1.09% , Spirit Airlines Inc. SAVE, +1.46% and United Continental to market perform from outperform. It upgraded the stock of WestJet Airlines Ltd. WJA, +2.90% to market perform from underperform. It said Delta Air Lines is its top pick in the sector, followed by Southwest Airlines Co. LUV, +2.54% , SkyWest Inc. SKYW, +3.15% and Volaris Aviation VLRS, +1.54% .
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“Both Delta and Southwest had headwinds from technology outages in [the third quarter of 2016], which provide for easier [comparisons] than their peers,” said Becker. “Also, both airlines have their labor agreements behind them, and those are no longer an overhang.”
Cowen now has four airline outperforms, with the remainder of carriers tagged with market perform ratings. The brokerage has no underperform ratings on the airline sector, with no real conviction to the downside for any stock.
The industry is putting the brakes on capacity growth, but it is still growing, said Becker. January should, in fact, be a strong month, given New Year’s Day and Christmas fell on Sundays, making it likely there would be a lot of return traffic on Jan. 2 and 3.
Greatest challenge lies in the Atlantic region, according to the note, although Cowen has taken a more negative view of that region than peers have.
“Despite American, Delta and United reducing capacity, we expect the market to be oversaturated with capacity growth from low-cost carriers,” said Becker. “If Latin America is any indication for how long this region could struggle we believe we are in the early innings of unit revenue deterioration and capacity concerns in that region.”
Airline stocks were trading higher Wednesday, led by Spirit Airlines, up 2%. The NYSE Arca Airline exchange-traded fund XAL, +2.03% was up 1.8% and has gained 35% in the last 12 months, while the S&P SPX, +0.61% is up 12.8%.