American and United Are Downgraded as 'Disillusion' With Airlines Will Persist, Analyst Says

Credit Suisse downgrades American Airlines and United Airlines, citing diminished expectations for gains in passenger revenue per available seat mile.
By Ted Reed ,

A leading Wall Street airline analyst sharply downgraded ratings for American (AAL) - Get Report and United (UAL) - Get Report , citing a combination of negative trends including weak trans-Atlantic demand, higher labor costs and slower-than-expected improvement in passenger revenue per available seat mile.

"Until unit revenues show firm evidence of improvement, which requires capacity discipline or a macro reacceleration, the disillusion with owning airlines will persist, with rallies limited to those led by risk-on appetites instead of improving fundamentals," Credit Suisse analyst Julie Yates wrote in a report issued Wednesday.

Yates downgraded American to underperform from outperform and downgraded United to neutral from outperform.

As airlines prepare to report second-quarter earnings, closely watched PRASM performances by American and United will likely "underwhelm," Yates said, noting, "For a sustained rally in the sector, we think investors need more and will want to hear capacity is being cut to drive improvement in unit revenues."

Among the negative factors, "corporate demand trends aren't good and there is incremental risk of further {currency exchange} headwinds and lower trans-Atlantic yields post Brexit," she said.

Additionally, she said, expensive labor deals have led to greater-than-inflation growth in cost per available seat mile excluding fuel, while higher fuel prices are compressing margins.

American shares closed Tuesday at $28.93 and are down 32% year to date. Yates cut her target price to $28 and cut her full-year 2017 earnings estimate to $4 a share. Analysts surveyed by Thomson Reuters estimated earnings of $5.33 a share.

Yates said her January upgrade of American was "admittedly one of our worst stock calls." She said she had expected PRASM gains starting in the second quarter.

As for United, shares closed Tuesday at $40.29 and have declined 30% year to date. Yates cut her target price to $48 and cut her full-year 2017 estimate to $5.08 a share. Analysts surveyed by Thomson Reuters estimated $7.72 a share.

Yates retained an outperform rating on Delta (DAL) - Get Report , but said she prefers primarily domestic airlines Southwest and Spirit "given international macro risk.

"Clearly, our downgrades of UAL and AAL are late and the market has already punished these names severely this year," she wrote. "However, our ratings are relative and we think several more quarters of PRASM disappointment may lie ahead."

This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.

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