JP Morgan Picks a Winner and Loser Among Low Cost Airlines

JP Morgan airline analyst Jamie Baker is making a yin and yang call in the sector today. Baker launched coverage on Spirit Airlines (NASDAQ: SAVE) with a bullish Overweight rating and Virgin America (NASDAQ: VA) with a bearish Underweight rating.

The analyst said while it is good to be a US airline company these days not all operating models are created equal. Baker said these "opportunistic skimmers" face differentiated challenges and earnings trajectories.

Spirit has their preferred model - it is both parasitic and opportunistic. Baker said while the investment timing may
not appear optimal given competitors are not giving an inch on market share, the new CEO Bob Fornaro is "likely to usher in a more 'moderate' approach towards competition and capital stewardship." They suspect he is under a direct mandate to improve SAVE's lagging share price. In addition, the wash out in buy-side sentiment suggests shares are positioned to move up on any tangible evidence of cessation in competitive hostilities. The analyst sees earnings growth for Spirit returning in 2017. "... after over-earning in 2015, we envision slightly below-consensus 2016 EPS of $3.65, followed by a consensus-topping $4.50 in 2017," Baker said. Meanwhile, while they are bullish on Fornaro, they don't believe M&A is forthcoming. "... we think the DOJ significantly regrets having ever opened the barn door to consolidation. .... it is difficult for us to envision permitting more airlines to graze unmolested in the pasture of consolidation," he said.

The firm set a $52 price target on SAVE, suggesting 42% upside to Wednesday's close.

On Virgin America, Baker said the company's Hybrid model and concentrated network pose unique challenges. Also the premium valuation leaves little room for error. Unlike Spirit, Virgin's costs are more representative of youth than structural, long-term design, which limits future margin expansion. The analyst said the the hybrid construct of premium service and youthful expenses "has proven difficult to sustain longer term." He pointed to JetBlue to illustrate this. In addition, given its tech-centric San Francisco hub, Virgin customer base is less immunized than Spirit's relative to any broader, economic slowdown.

The firm set a $31 price target on VA, suggesting limited upside to Wednesday's $30.42 close.

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