Why Are Airline Stocks Struggling?

In the past three months, airline stocks have severely lagged the S&P 500. In fact, since the beginning of March, the U.S. Global Jets ETF JETS has delivered a 12.5 percent loss while the SPDR S&P 500 ETF Trust SPY is up 2.8 percent.

The airliner underperformance has accelerated this week. According to Morgan Stanley analyst Rajeev Lawani, the weakness is all about skeletons in the closet for the airline industry.

“While our fundamental work indicates that airliners should post meaningful profitability vis-à-vis past downturns (with double-digit industry operating margins) and even manage break-even to modestly positive free cash flow, we do acknowledge the interim downside as these concepts are proven to the market and valuation reflects such,” Lawani explains.

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Airliners have witnessed profits fall deep into negative territory during past cyclical downturns in the U.S. economy, and Morgan Stanley believes that the market doesn’t trust that the next downturn will be different.

Lawani expects carriers with the highest operating margins, such as Allegiant Travel Company ALGT and Alaska Air Group, Inc. ALK, are best-positioned to weather the next economic downturn. American Airlines Group AAL and United Continental Holdings Inc UAL have the lowest operating margins under Morgan Stanley’s airline coverage.

The firm maintains Overweight ratings on American, Alaska Air, Delta Air Lines, Inc. DAL and United.

Disclosure: the author holds no position in the stocks mentioned.