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Imperial's McAdoo Says Investors Should Value Airlines On Profits, Not RASM

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Imperial Capital analyst Bob McAdoo released a report this week explaining what he sees as flawed logic used by the market in valuing airline stocks. While many airline investors focus on the industry-specific revenue per available seat mile (RASM) metric, McAdoo believes that the best indication of the performance of the airliners is good old-fashioned profits.

The Rise Of RASM

Back when oil prices were around $100/bbl, the airlines focused on cutting capacity and improving RASM in order to improve operational efficiency, maintain adequate margins and generate profits. Analysts and investors became focused on RASM, rather than profits, as an indicator of the strength of the airlines.

Cutting Capacity

McAdoo explains that the best way to improve RASM is to cut back on capacity by eliminating certain flight destinations, cutting the number of weekly departures or a combination of the two. He explains that, for airlines, cutting capacity is analogous to retail chains closing their weakest stores.

A New World

McAdoo’s argues that capacity cuts made sense when oil prices were so high that many flights had very modest or even negative margins.

“However, with $50 per barrel oil driving several hundred basis points of margin improvement across all airlines, it is likely that virtually all the formerly negative margin flights are now profitable,” he explained.

McAdoo believes that reducing capacity by cutting profitable flights simply to boost RASM numbers is not a logical way to run a business and that the primary focus should always be the companies' bottom lines.

Stock Picks

Despite his criticism, McAdoo remains bullish on airline stocks in the current environment. Imperial’s top airline stock picks are Southwest Airlines Co (NYSE: LUV), American Airlines Group (NASDAQ: AAL), Allegiant Travel Co (NASDAQ: ALGT), Spirit Airlines Incorporated (NASDAQ: SAVE) and Delta Air Lines, Inc. (NYSE: DAL).

Latest Ratings for LUV

DateFirmActionFromTo
Feb 2021Deutsche BankUpgradesHoldBuy
Jan 2021Credit SuisseMaintainsOutperform
Jan 2021SusquehannaMaintainsPositive

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Related Articles (LUV + AAL)

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