Morgan Stanley Ahead Of Q3 Earnings In Airline Sector: 'Potential To Keep The Momentum Going'

• Shares in the Airline sector have broadly outperformed the S&P 500 and the DJT in the week ended October 9 and is down 12.1 percent year-to-date.
• Morgan Stanley’s Rajeev Lalwani has an Attractive rating on the Airline sector.
• Lalwani said that the companies were meeting expectations, while projecting capacity declines and a slowdown in headwinds.

Airlines stocks have appreciated 6.1 percent over the week ended October 9, as compared to a 3.3 percent rise in the S&P 500 and a 4.8 percent increase in the Dow Jones Transportation [DJT]. Analyst Rajeev Lalwani added, however, that year-to-date, the shares are down 12.1 percent, underperforming the S&P 500 by 1,000 bps and the DJT by 240 bps.

Airline stocks have come under pressure on account of oversupply, currency volatility, low fuel surcharges, and stiffening competition. “With that said, the major US airlines have come up off their lows over the past few months and we believe this momentum has the potential to keep going,” Lalwani said.

The reasons for optimism are that the companies are beginning to meet expectations, capacity would probably decline through 2016, channel checks indicate that the competitive landscape has not worsened and forex and surcharge headwinds are likely to abate going ahead.

All these factors should result in improving unit revenues. “Moreover, airlines continue to grow ancillary revenues and executing on robust capital return programs, returning ~2% of market cap this quarter,” the analyst wrote.

United Continental Holdings Inc UAL [Rated: Overweight, PT $96] has raised its guidance for 3Q, resulting from an upward revision in PRASM expectations to a decline of 5.5-6.0 percent, from a decline of 5-7 percent. The guidance was raised despite concerns over the broad unit revenue environment.

The PRASM revision, effective cost management and higher other revenues translate to 3Q pre-tax margins of 16-17 percent, versus the previous expectation of 13.5-15.5 percent, Lalwani mentioned.

American Airlines Group Inc AAL [Rated: Equal-Weight, PT $50] reiterated its 3Q PRASM expectations of down 6-8 percent, while reducing its projections for fuel to $1.65-$1.70/gal from $1.73-$1.78/gal and for CASM ex-fuel to +2-4 percent from +3-5 percent. The company raised its guidance for pre-tax margins from 16-18 percent to 17-18 percent.

In the report Morgan Stanley noted, “The biggest surprise in the update was a significant step-up in share repurchases with the airline returning $1.56B or ~5% of its market capitalization as it successfully tapped the debt markets while continuing to keep an elevated cash balance (of nearly $10B).”

The A4A PRASM declined 7.8 percent y/y in August, YoY, as compared to a 3.9 percent decline. “The current jet fuel spot price is $1.40/gal. vs. prior week's $1.42/gal. and represents a decline of ~51% YoY,” Lalwani wrote.

Morgan Stanley has projected for November and December 2015:

• US total industry ASM YoY growth at 4.1 percent, 4.3 percent
• Seat growth at 4.3 percent, 4.2 percent
• Departure growth at 0.8 percent, 1.4 percent
• Flight hour growth at 2.6 percent, 2.8 percent

Morgan Stanley has Overweight ratings on Delta Air Lines, Inc. DAL [PT $62], Spirit Airlines Incorporated SAVE [PT $66] and Alaska Air Group, Inc. ALK [PT $95], Equal-Weight ratings on Allegiant Travel Company ALGT [PT $230] and JetBlue Airways Corporation JBLU [PT $29] and is Underweight on Southwest Airlines Co LUV [PT $42] and Virgin America Inc VA [PT $37] and Hawaiian Holdings, Inc. HA [PT $27].