Morgan Stanley Grounds Airliners, Downgrades Sector To In-Line From Attractive

In a Wednesday morning note received by Street Insider, Morgan Stanley analyst Rajeev Lalwani says pricing disconnects are swelling as oil prices drop and supplies rise.

Lalwani comments "We predicated our previous Attractive view on capacity that was under control and adjusting to margins, which has played out since mid-2015 (US Airlines up ~15% vs. S&P 500 up ~10%). However, our forecast now suggests this may no longer be the case as Domestic supply reaches 4-5% for 2017 / 2018, but margins deteriorate and pricing stagnates."

Hitting on the growth in supply, Lalwani says "Considering supply that is reverting to 2015 / 2016 levels and lower fuel that introduces disruption risk, we forecast margin degradation of almost 500bps in 2017 with marginal declines thereafter. The net of our top-line skepticism (MSe of flat RASM in 2017 / 2018 vs. consensus of 1%+) and higher supply / lower fuel maintains our EPS below consensus by ~5% as we downgrade our Industry view to In-Line given multiple expansion that feels less attainable at this point. While tactically the stocks may run after weakness, the outlook is consistent with our updated Industry view over a 12-18 month investment horizon."

This dynamic leaves a negative outlook for margins, specifically for American Airlines (NYSE: AAL) which was downgraded in the same note (read more here).

Addressing the margin "degradation ahead" Lalwani wrote "For the industry more broadly, our estimates show operating margins compressing marginally moving forward and AAL is no exception. Despite costs being quite visible after wrapping up labor negotiations and fuel falling even lower, the absence of much-needed pricing strength may drive margins lower at all Legacy carriers (by up to 50bps annually)."

To sum it all up, Morgan Stanley sees limited room for expansion from here for Airliners.

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