In a research note examining the downtrodden sector reported on by Reuters, JPMorgan singled out industry juggernauts American Airlines (AAL) and United Continental Holdings (UAL), together with budget carrier Spirit Airlines (SAVE), as the biggest victims of current industry dynamics. The analysts downgraded all three from "overweight" to "neutral" based on concerns that rising fuel costs and ongoing domestic pricing weakness could prevent them from hitting consensus estimates. Similar fears also led the brokerage to cut its target price on Delta Air Lines (DAL).
Analyst Jamie Baker and his colleagues noted that current consensus hints that fourth quarter Revenue per Available Seat Mile (RASM) metrics could be set to improve. They disagree with this assessment, arguing instead that industry headwinds are likely to persist, and maybe even worsen, throughout the year.
RASM is carefully watched by investors to gauge industry efficiency and profitability. By dividing passenger revenue by available seat miles, investors are effectively able to establish the amount of revenue that airlines generate from each seat.
Passenger revenues are expected to come under further pressure from ongoing pricing wars between major airlines and discount carriers, a conundrum that has already triggered a sell-off across the sector. Aside from being forced into lowering prices to remain competitive, airlines will also have to contend with surging costs, owing to the recent rise in the price of jet fuel.
The Irma and Harvey hurricanes have driven up the cost of jet fuel. Given that airlines buy millions of gallons of the stuff to power their planes, this situation is expected to impact profits across the sector.
Nevertheless, JPMorgan believes that some stocks should be able to weather these challenges better than others. The brokerage firm noted that Alaska Air Group (ALK), JetBlue (JBLU) and Southwest Airlines (LUV) look particularly “attractive” at current levels, prompting it to lift its price targets on all three of the stocks.
JPMorgan upgraded Southwest Airlines from "neutral" to "overweight," arguing that the world's largest low-cost carrier offers an attractive valuation and better risk-reward profile compared to rivals. (See also: Watch Airline Stocks For Takeoff Potential.)