Low Airline Expectations Could Actually Yield Slight Upside, JPMorgan Says

Low expectations from airlines could actually yield slight upside in the near term, according to a note from JPMorgan, which prefers Overweight names such as American Airlines Group Inc AAL, United Continental Holdings Inc UAL and Delta Air Lines, Inc. DAL.

"Given the absence of any bona fide 'misses,' diminished investor expectations may actually yield modest equity relief in the near term, given the potential for incremental capacity cuts and 'less bad' RASM commentary as earnings season soon gets underway," analyst Jamie Baker wrote in a note to clients.

Baker noted that "cost convergence, fare unbundling, widespread consolidation, diminished new entrant activity, and return-oriented management teams have combined to form an industry that is actually managing itself for the first time we can recall. This stands in sharp contrast to the historical tendency to wage wars of attrition."

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The analyst continued, "As a result, we believe the US airline industry will continue to take steps to ensure profitability and continued balance sheet repair."

As such, the analyst recommends investors to focus on airline stocks such as American Airlines, United Continental and Delta Airlines.

American Airlines: Overweight, PT $50.50

"We are now modeling for a pre-tax margin of ~12.5 percent (the lighter end of the 12–14 percent pre-tax margin guide), and our Q1 EPS is lifted by $0.03 to $1.20 (mostly on a lower share count) as we expect the current consensus $1.12 to move towards the $1.20 mark."

"[W]e view AAL has highly compelling valuation, favorable industry dynamics, a management experienced in merger integration, and merger-related profit potential exceeding what most appear to believe."

United Continental: Overweight, PT $66.50

"Our Q1 EPS moves up to $1.18 (from a low-end $1.04), and sits just above consensus $1.16."

"We rate UAL shares Overweight and acknowledge a compelling risk-to-reward proposition, as we believe the major Continental merger integration hurdles are seen through the rearview mirror."

Delta Air: Overweight, PT $66.00

"A lower tax rate of 34 percent vs. our prior 38 percent drives $0.06 of EPS upside and we are now estimating Q1 EPS of $1.32 vs. $1.26 previously and slightly above consensus $1.30."

"We recommend investors focus on airline stocks such as Delta, which we rate Overweight given what we view as compelling valuation and favorable industry dynamics with potential to attract significant longer-term investor interest versus when the industry operated in a more capital-destructive manner."

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