Bernstein Raises Price Targets On 4 Airline Stocks; Prefers Southwest

Premised on a trio of factors, Bernstein on Monday updated its thesis on the airline industry, with the factors being: 1) extension of the current cycle of better passenger, revenue per available seat miles ( PRASM), 2) an increase in volatility and discount rates and 3) heightened prospects for tax reform.

Analyst David Vernon noted airline stocks have been higher since the election, with high beta trade working a little better at the margin. The analyst believes market focus on PRASM and sequential unit revenue improvement when weighed against a material decline in forward earnings estimates have led to about 30–50 percentage point multiple expansion since summer.

Updating PRASM Outlook

To reflect better yields, Bernstein updated its PRASM outlook. The firm is of the view that the markets will gloss over the risk of fare increases being offset by lower utilization until it begins to show up in the numbers.

Bullish On Near-Term Cash Stories

The firm believes the valuation gap between cash today and cash tomorrow will widen, as discount rates and interest rates go higher. Accordingly, the firm believes lower beta names, the ones that can return more cash or deleverage more in the current cycle, would be benefited.

Tax Reforms Broadly Positive

Bernstein also believes the potential impact of tax reforms on earnings and cash flows for the airlines to be broadly positive, although it could vary with specific companies. The firm expects the benefits of the tax change to show immediately at Southwest Airlines Co LUV, but deferred for other carriers.

Assuming an expected 50 percent value and discounting value based on NOLs, the firm sees per share value of tax reform to be $4 for American Airlines Group Inc AAL, $7 for Delta Air Lines, Inc. DAL, $9 for United Continental Holdings Inc UAL and $10 for Southwest Airlines.

Valuation Red Flag If Unit Revenue Doesn't Keep Pace

That said, the firm remains wary, as the rapid pace of multiple expansion and the singular focus on a non-cash based valuation trade make the sector ripe for profit taking at the first sign of unit revenue trouble. The firm believes heading into the New Year, investors will closely watch stock versus sector positioning and begin to factor what higher discount rates and tax reform could mean for individual airline stocks.

The firm updated its models and target prices to reflect macro changes and cost guidance, premising much of the upward price target revision to better outlook and some of it to tax. The firm also said it thinks the market is underpricing the cash flow at Southwest Airlines and Delta Air Lines and is too optimistic on American Airlines and United Continental.

Ratings/Price Targets

• American Airlines: Underperform rating; price target raised to $42 from $31.
• Delta Air Lines: Market Perform; raised to $57 from $44.
• Southwest Airlines: Outperform; hiked to $63 from $50.
• United Continental: Market Perform; lifted to $76 from $59.