Long-term investors in airline stocks need to be patient and "stay the course," despite several "pushbacks" against the bull case for investing in the sector, according to one veteran airline industry analyst.
Those pushbacks include weak domestic pricing, rising jet fuel prices that are not translating into higher fares, the likelihood that airlines are likely "over-earning" if the government steps in to eliminate baggage fees to fix long delays at security lines, a premature recession due to a Fed rate hike (airlines are cyclical) and Europe becoming less stable over fears of Brexit and terrorism, according to two industry notes by Sterne Agee CRT analyst Michael Derchin.
Derchin argued that while valuations for airline stocks "are more than half of quality industrial companies," long-term shareholders should "stay the course and remain net long on the group," despite a handful of industry pushbacks. In both notes, he reiterated his top four airline stocks, which include Southwest Airlines (LUV) , Hawaiian Holdings (HA) , Delta Air Lines (DAL) and Spirit Air Lines (SAVE) .
Here are snippets of what Derchin had to say about each of the stocks in recent single-stock research notes.
Southwest Airlines (LUV) is Derchin's top pick among airlines. Southwest Airlines shares are down 1.2% this year.
He rates the company at buy with a $67 price target.
Following "record" first-quarter results, Derchin maintains above-consensus estimates and his $67 price target, given "'off-peak' margins the best in 35 years," he wrote on April 27.
"Bucking industry trends, RASM (revenue per available seat mile) rose slightly, and is expected to increase 0.7% in 2Q16. Unlike its peers, record 1Q16 earnings came the 'old fashioned way' from top-line growth (9% revenue growth) and cost controls (flat CASM ex-fuel), with fuel costs down only 3%, due to hedge losses," he wrote. "Returns on new Dallas Love Field long haul routes are above system averages, belying criticism of its unique brand appeal in longer haul routes ('bags fly free,' no change fees, and warm, friendly customer service are universally loved, it appears). LUV remains our best idea."
Shares of Hawaiian Airlines (HA) are up 13.4% this year.
Derchin rates the company at buy with a $58 price target.
After meeting with Hawaiian Airlines management, Derchin came away with several positive takeaways, noting that the company is "bucking industry trends," in a May 11 note.
"HA is on track to have positive unit revenue performance in '16 as a result of muted competitive capacity growth, strong demand, and FX tailwinds," the note said.
Shares of Delta Air Lines (DAL) are down 14.2% this year.
Derchin rates the company at buy with a $67 price target.
"Management of Buy-rated Delta Air Lines, Inc. was the first network airline to recognize the risks inherent in the cyclical, competitive and high fixed cost airline industry and, in our view, put into place a plan to de-risk its business, identify financial goals, make them transparent to foster accountability and reward stakeholder, based on execution of the plan," Derchin wrote on May 16. "Today, DAL announced reduced capacity growth below 2% for 2H16, deferral of 4 A-350's to 2019/2020 from 2018, 50% dividend increase (2% yield) and affirmed that 70% of $4.5-$5.5 billion free cash flow to be returned to shareholders."
Shares of Spirit Air Lines (SAVE) are up 9% this year.
Derchin rates the company at buy with a $62 price target.
Derchin says the stock is "incredibly undervalued" and is his favorite mid-cap idea in the sector. That said, he lowered his earnings estimates on the company to reflect a more competitive environment and "time required by new management to make tactical adjustments to tweak its proven business model," he wrote on April 26.
Derchin lowered his second-quarter EPS estimate by 20 cents to $1.07 a share. For the year, Derchin is estimating EPS of $4.21 a share, according to the note.
"SAVE has a proven business model that only needs tweaking, not fixing, in our view. New CEO Bob Fornaro is already proving to be flexible and nimble in making necessary tweaks," he wrote.