Goldman Sachs: Airlines Need To Restore Pricing To 'Ensure They Can Earn' Adequate ROC

In a report published Friday, Goldman Sachs analyst Tom Kim mentioned that it would not be appropriate to assume fuel prices will “remain this low,” and therefore US airlines need to “restore pricing to ensure that they can earn an adequate return on capital.”

The Department of Justice is investigating a potential collusion in the US airline industry. The four largest US airline stocks have declined 23 percent year-to-date, resulting in a reduction in their market cap by $31.6bn. Analyst Tom Kim believes that the pressure on shares was mainly due to “declining earnings expectations and overcapacity concerns.”

In the report Goldman Sachs noted, “Yields have declined 4 out of the last 6 months, with market conditions worsening due to weaker-than-expected demand. As a result we believe airlines need to cull capacity to bring market pricing back to equilibrium.”

If it had not been for the 42 percent downturn in fuel prices year-to-date, Kim estimates airline earnings to have dropped by 36 percent y/y.

“We believe that the industry cannot assume fuel prices will remain this low, and therefore airlines need to restore pricing to ensure that they can earn an adequate return on capital,” the report added.

While fuel costs are down, so are yields. However, capital requirements remain elevated, with airlines reinvesting in their fleet, networks and people. Wage inflationary pressure has resulted in a rise in labor costs. “Thus, pricing needs to improve, in our view. As a result, we think capacity needs culling,” Kim pointed out.

Goldman Sachs has the following ratings and price targets for the US airlines:

• American Airlines Group Inc AAL – rated Buy, PT at $61
• Delta Air Lines, Inc. DAL – rated Buy, PT at $60
• United Continental Holdings Inc UAL – rated Buy, PT at $81
• JetBlue Airways Corporation JBLU – rated Neutral, PT at $21
• Southwest Airlines Co LUV – rated Buy, PT at $58