UBS has recently adjusted its coverage of U.S. airlines, issuing Buy ratings for Alaska Air Group, Delta Air Lines, and United Airlines, while downgrading Southwest Airlines and JetBlue Airways to Sell. This strategic shift comes as the bank analyzes the current supply-demand dynamics, revenue diversification, and balance sheet strength within the airline sector.
UBS anticipates that capacity reductions will enhance revenue per available seat mile (RASM) and improve profit margins across the industry by 2025. The bank's research indicates a significant downshift in supply growth, projecting a decrease from 5%-6% in the first half of 2024 to just 1%-2% in the latter half. This reduction is expected to create a more favorable supply-demand balance, which should support revenue growth.
Delta, United, and Alaska have been recognized for their robust and diverse revenue growth drivers, alongside healthier balance sheets, positioning them well to navigate potential risks such as cost inflation and fluctuations in travel demand. Their high single-digit pretax margins serve as a testament to their resilience in a challenging market.
In contrast, Southwest Airlines and JetBlue Airways are facing significant headwinds, prompting UBS to adopt a cautious stance. The bank highlighted Southwest's weak pretax margin projection of approximately 1% for 2024, coupled with concerns regarding its valuation and execution risks. JetBlue's outlook is even more troubling, with a negative margin projection of -5.2% for 2024 and a high leverage ratio of 8.7 times net debt to EBITDAR. These factors have led UBS to downgrade both airlines, reflecting a lack of confidence in their ability to recover in the near term.
Broader industry challenges also loom large, including elevated debt levels, ongoing supply chain disruptions, and production issues stemming from original equipment manufacturers (OEMs) like Boeing. The pressure on RASM in the first half of 2024, attributed to excess capacity, has prompted several airlines to respond swiftly by reducing their operational capacity. This proactive approach is seen as essential for maintaining profitability in a competitive landscape.
Despite the challenges, UBS identifies corporate travel as a potential bright spot for the airline industry. According to a proprietary survey conducted by UBS's Evidence Lab, 97% of U.S. travel managers expect their spending to remain flat or increase in 2025. This optimistic outlook for corporate travel could provide a much-needed boost to airlines, particularly those with strong revenue diversification strategies. The emphasis on corporate travel aligns with the broader trend of businesses gradually resuming travel activities as pandemic-related restrictions ease. As companies adapt to new norms, the demand for corporate travel is expected to rebound, offering airlines an opportunity to capitalize on this segment. The ability to cater to corporate clients, who often contribute higher margins, could further enhance the financial stability of airlines that are well-positioned to meet this demand.
UBS's methodology for evaluating airline stocks places a premium on diverse revenue streams, robust balance sheets, and proven profitability. This analytical framework has led the firm to favor Alaska Air, Delta, and United as its bullish picks within the sector. These airlines have demonstrated a capacity to generate revenue from various sources, which is crucial in an environment marked by uncertainty and volatility.
As the airline industry navigates through these turbulent times, the focus on financial health and adaptability will be paramount. Airlines that can effectively manage their costs while capitalizing on emerging opportunities, such as the anticipated growth in corporate travel, are likely to emerge stronger. The evolving landscape of the airline sector will require stakeholders to remain vigilant and responsive to market changes, ensuring that they are well-equipped to tackle both challenges and opportunities as they arise.