2016 Airline Outlook: 'Profits Higher On Lower Fuel'

• Shares of most airline stocks have appreciated over the last six months.
• Credit Suisse’s Julie Yates has a positive view for the sector.
• Stocks may remain range-bound in the near term, until there is visibility into where pricing is heading in 2016, Yates stated.

Analyst Julie Yates mentioned that 2016 would be the 7th year of industry profitability, and the risk/reward still appeared favorable. She added that there has been a further widening of the valuation gap to other industrials as well as to the S&P500, with P/E ratios being “among the least expensive.”

Although unit rev trends continued to be weak, investor expectations had become more realistic than heading into 2015. Moreover, carriers had demonstrated “the utmost capital discipline in a low fuel environment.” Yates commented that this had driven permanent capital structure improvements and that shareholder returns continued to rise.

In the report Credit Suisse noted, “Macro stability (economy, fuel, FX) is key & the absence of PRASM misses is paramount as carriers need to prove relatively stable pricing despite the most recent leg down in fuel.” Yates said that there could be more positive catalysts in 2016 as compared to the large number of negative catalysts witnessed in 2015.

The analyst added that comps would ease as the year progresses, capacity growth is likely to peak in Q1 and ongoing IT improvements would boost pricing and revenue management. “High margin sources of revenue are expanding for most with recent credit card extensions, which should enable total RASM to outperform PRASM, protecting non-fuel margin.”

Rating And Price Target Changes

• American Airlines Group Inc AAL upgraded from Neutral to Outperform, with price target raised from $52 to $57.
• Alaska Air Group, Inc. ALK downgraded from Outperform to Neutral, with price target reduced from $95 to $90.

Top Picks In 2016

• Southwest Airlines Co LUV – Rated Outperform, with price target raised from $56 to $58.
• Delta Air Lines, Inc. DAL – Rated Outperform, with price target reduced from $68 to $65.
• United Continental Holdings Inc UAL – Rated Outperform, with price target reduced from $88 to $87.
• American Airlines