Airline Valuations Are Flying Low, With Delta and Others Presenting Opportunities, Deutsche Says

The sector `meaningfully underperformed' the S&P 500 this year, and analyst Michael Linenberg lays out the case for buying Delta and other carriers.
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Deutsche Bank suggests that investor portfolios will get a lift from airline stocks, after the sector "meaningfully underperformed" the S&P 500 this year.

Analyst Michael Linenberg upgraded Delta Air  (DAL) - Get Report to buy from hold and boosted his target price on the Atlanta carrier to $70 from $61.

He also lifted target prices on JetBlue  (JBLU) - Get Report, to $26 from $23,  and United  (UAL) - Get Report, to $110 from $108. He trimmed his target on Southwest  (LUV) - Get Report to $62 from $65.

And he said he especially favors buy-rated Delta, United and American Air  (AAL) - Get Report.

"[Demand] trends remain solid ... and valuations are at historical lows vis-à-vis the market with major airline price-to-earnings multiples now trading at an about 60% discount to the S&P 500," he wrote in a Dec. 18 industry report. 

A year ago, he said, few would have expected healthy revenue growth, fatter margins and an accommodative monetary policy to result in the sector underperforming the market in 2019. But it happened -- except at Allegiant  (ALGT) - Get Report and Skywest  (SKYW) - Get Report, where the shares rose 78% and 45% respectively this year, he said.

"For 2020, we see another healthy year of industry profits (albeit at modestly lower margins) ... driven by an improved outlook for global GDP, growing share of ancillary revenue (which tends to be more profitable and stable than passenger airline revenue), and strong free-cash-flow generation," Linenberg wrote.

Risk related to additional capacity coming online when Boeing  (BA) - Get Report gets the 737 MAX back up and flying is now reflected in the share prices, he said. 

On the other hand, valuations at American, Alaska Air, Southwest and United may not yet reflect the prospect that Boeing will pay potentially "substantial" compensation to the airlines, he said.

The 737 MAX was grounded last spring after two crashes, in Ethiopia and Indonesia, over five months in 2018 and 2019 killed 346 people. 

The Chicago aerospace giant recently said it would indefinitely suspend production of the 737 MAX after the plane failed to meet the company's target for recertification by the Federal Aviation Administration.

In particular to Delta, Linenberg wrote, the carrier is on track to grow revenue 7% in 2019 and it targets 4% to 6% growth in 2020.

Management has been "making a case for why Delta and the U.S. airline industry have far more growth potential than most investors realize," he said. 

"Bolstering that view are the above-average growth rates of the company's other revenue segments, such as ancillary, loyalty, and maintenance, repair and overhaul, as well as more exposure to international markets, which are growing at a faster rate than the U.S. market (and some of these segments are higher margin than the core business)."