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Goldman Sachs Comments on Weakness in Airlines, Expects Behavior to Remain Rational (LUV) (AAL) (DAL) (UAL)

May 21, 2015 10:28 AM EDT
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Goldman Sachs analyst Tom Kim thinks investors should accumulate airlines on recent weakness. The group declined sharply Wednesday amid concerns related to domestic pricing and capacity discipline. Kim expects carrier behavior to remain rational and he called into question the thesis that 'this time will be different.'

"US airline stocks dropped an average 6.6% on May 20, which we attribute to investor concerns around domestic pricing and capacity discipline. We believe that it is an important reminder to the industry that investors are closely monitoring carrier behavior," said Kim.

Kim noted investors were disappointed that Southwest Airlines (NYSE: LUV) raised its 2015 capacity growth to 8% from 7%, but a greater impact on investor sentiment may have been caused by American Airlines (NASDAQ: AAL) commentary Tuesday that it would compete aggressively against low cost carriers on price to defend share.

"Thus far, domestic pricing and capacity behavior has been rational. There are certain pockets where capacity has been growing disproportionately, such a Dallas and Seattle, but overall ASM (+3.2%) have been increasing largely in-line with RPM (+2.9%) ytd," noted Kim.

“The domestic market has fueled the multi-year airline rally, as rational pricing in a favorable supply/demand environment drove topline growth. Following years of consolidation, supply discipline, de-leveraging, and cost take-out execution, industry participants began to suggest that ‘this time is different’. However, recent events reflect that the industry remains competitive and we remain in the “show me” camp,” continued the analyst.

Kim added, “Following Wednesday’s sell-off our coverage group now trades at 8.8x on P/E, representing a 10% discount to the five-year average. While we expect concerns around pricing to continue to pressure shares, current valuations should provide support. The industry’s earnings power, high free cash flows, reduced financial leverage and capital returns offer a compelling risk/reward.”

Effected stocks include Allegiant Travel (NASDAQ: ALGT), Alaska Air Group (NYSE: ALK), Delta Air Lines (NYSE: DAL), Hawaiian Holdings (NASDAQ: HA), JetBlue Airways (NASDAQ: JBLU), Spirit Airlines (NASDAQ: SAVE), Virgin America (NASDAQ: VA), United Airlines (NYSE: UAL).



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