Is Virgin America The Only Airline Worth Shorting?

Sterne Agee CRT’s Michael Derchin has an Overweight stance on the US Airline Industry, and recommended using pullbacks to add to or initiate new positions. The industry had been through 35 years of consolidation and restructuring, which have “dramatically improved” its fundamentals.

Although volatile jet fuel prices, economic slowdowns, and black swan events would continue to be concerns, the group has come up with “more stable and profitable business models,” analyst Michael Derchin said.

“The historic “boom-and-bust” cycle will likely be replaced with a much more stable, extended cyclical growth cycle, with higher earnings in expansions and lower earnings (but not red ink) in recessions,” Derchin wrote. He pointed out that US airlines had recorded unprecedented profits since 2010, even in the face of volatile jet fuel prices. They had achieved this through consolidation, capacity discipline, ancillary revenue and cost controls.

US airlines could generate record profits throughout the current cycle. Derchin forecasted pretax profits to reach $28.5 billion in 2016, with pretax margins averaging nearly 18 percent. He expects low jet fuel prices to be a key contributor to the 2016 results.

Derchin further commented that the ten largest US airlines had avoided bankruptcy in the previous bust cycle, while their operating margins narrowed only modestly by historic standards.

Terming the more stable business models as a “permanent positive change,” the analyst mentioned that improvements in the balance sheets are resulting in the airlines are offering attractive capital returns to shareholders. The airlines returned $10 billion in 2015, via share buybacks and dividends.

The returns to shareholders are expected to increase in 2016, “given current share repurchase and dividend authorizations and managements’ willingness to authorize new and more lucrative plans,” the Sterne Agee CRT report noted.

Ratings And Comments

• Southwest Airlines Co LUV – Rated Buy, PT: $67 – Named Top Pick for 2016
• Spirit Airlines Incorporated SAVE – Rated Buy, PT: $68 – Termed as Best Mid-Cap Idea
• Hawaiian Holdings, Inc. HA – Rated Buy, PT: $58 - Industry-leading RASM growth forecasted
• JetBlue Airways Corporation JBLU - Rated Buy, PT: $33 - Investments in the business seeded to be paying off
• Alaska Air Group, Inc. ALK - Rated Buy, PT: $100 – Forecasted to record the highest margins in 2016
• Delta Air Lines, Inc. DAL - Rated Buy, PT: $65 - Best risk-reward among “Big 3”
• American Airlines Group Inc AAL – Rated Buy, PT: $52 – Seemed to be enhancing long-term value amid near-term challenges
• United Continental Holdings Inc UAL – Rated Buy, PT: $70 - Return of CEO is a “Welcome Surprise”
• Allegiant Travel Company ALGT – Rated Neutral, PT: $165 – Airline could have a challenging year ahead in 2016
• Virgin America Inc VA – Rated Underperform, PT: $23 – Likely to witness persisting RASM and margin pressures