Morgan Stanley Upgrades Southwest; Sees Better Value In Alaska Air, Delta

• Southwest Airlines Co LUV shares have plunged 13 percent since December 8.
• Morgan Stanley’s Rajeev Lalwani upgraded the rating for the company to Equal-Weight, while raising the price target from $50 to $51.
• The recent pullback and expectations for improvements call for the upgrade, Lalwani stated.

Southwest’s shares have recently declined by more than 10 percent. Combined with this, the company seems well positioned for “more stable unit revenues from capacity growth halving post 1Q16 and fewer development markets,” analyst Rajeev Lalwani said.

The analyst also cited a pending reservation system upgrade worth "hundreds of millions" in revenues and “fuel hedges that will eventually roll-off.” Moreover, given that the airline cycle is in the later stages and there are macro uncertainties, higher quality airlines like Southwest “may fare better.”

While Southwest’s value proposition has improved, the rating has not been changed to Overweight due to the presence of other quality names like Alaska Air Group, Inc. ALK and Delta Air Lines, Inc. DAL, Lalwani pointed out. He added that these carriers offered better multiple expansion as well as capital return potential.

Moreover, the lower fuel environment was allowing peers to "catch-up," with carriers actively reducing debt, increasing shareholder returns, and purchasing aircraft.

“All the while, LUV's existing hedge profile of ~40% (~$75/bbl oil equivalent) limits the relative windfall,” the Morgan Stanley report noted.