J.P. Morgan releases its valuation for worldwide airlines

Darren Wood
By Darren Wood September 16, 2019 10:59

J.P. Morgan releases its valuation for worldwide airlines

J.P. Morgan has released its valuation for airlines across the world, highlighting some of the major airlines in each region.

In the Latin America region the report says that after several years of a challenging demand environment and great focus on growth, airlines have been adopting a more rational strategy toward capacity management and pricing.

In Brazil, the exit of Avianca Brasil has led Azul, GOL and LATAM to accelerate capacity expansion into the second-half of 2019, a fact that has brought some concerns to the investor community, the report says.

J.P. Morgan says that it does not see a scenario of excess capacity that could eventually lead to lower yields or unit revenue. Overall J.P. Morgan has said that it maintains a positive view for the airline industry in the region and reiterate Azul and Copa as our top picks.

Meanwhile, in North America, 2019 to date has marked the first year in four where margins (both operating and pretax) have expanded, and have done so at a rate superior to the S&P 500 (ex-financials). The report says that the industry has benefited from considerable pricing power as 2019 capacity plans tightened in response to higher fuel in the prior year, resulting in stronger earnings, while fuel has again trended down from the recent peak in April.

The grounding of the 737 Max has contributed to further capacity growth discipline this year which has been beneficial to the industry as a whole, with the exception of Southwest.

J.P. Morgan remains of the view that the Max will return in early 2020 which may result in sizable relative capacity growth (particularly in the second half). However, as Max-operated flights are already loaded and selling, the report expects the impact on shares from additional capacity and any potential year-on-year RASM declines to be more muted than some of our competitors.

Delta Airlines remains J.P. Morgan’s top pick and it continues to view it as the industry benchmark, generating the highest margins of its legacy peers as a result of structural benefits that will be difficult for others to recreate.

Over in Europe, there has been a better capacity discipline (helped by Max delays and bankruptcies) and less ATC disruption this summer, UK demand has been impacted by Brexit and Western European demand by a slowing economy. A fare war in Germany and Austria has added further pressure to yields for Ryanair, Easyjet and Lufthansa. Eastern Europe has performed relatively better given a more favourable macro picture and hence J.P. Morgan reports that its remain overweight structural winner to be Wizz Air.

In Japan, J.P. Morgan has been cautious on the air transportation sector for some time because of poor visibility on downside risk for the passenger load factor and yield from full-year 2019 onward due to an increase in industrywide supply. The firm says it is still not bullish on the air transportation sector, even though shares have underperformed in relative terms, because of the recently emerging risk of a slowdown in demand.

Against this backdrop, J.P. Morgan expects Japan Airlines (JAL) to experience relative outperformance in the sector due to the company’s emphasis on shareholder returns.

India is one of the fastest-growing aviation markets with 20% traffic growth over the past five years, according to Deepika Mundra. Full-year 2020 saw industry consolidation, with the bankruptcy of Jet Airways taking out 15% of domestic capacity and nearly 1/3rd of the international capacity of domestic carriers. Industry consolidation has led to yield improvement. Indigo is the largest domestic player with 48% market share and is expected to grow ASKs at 30% CAGR over the medium term.

The “supply-side reform” implemented by the Civil Aviation Administration of China (CAAC) since October 2017 is still ongoing, restricting slot capacity growth at 22 major airports in China, in a bid to improve flight punctuality. Chinese airlines’ fleet growth are also controlled by the CAAC, thereby providing capacity discipline. On the demand side, international outbound travel growth remains robust but domestic travel growth has seen a slight slowdown, likely due to the effects of China’s GDP growth slowdown.

However, demand growth still exceeds supply growth at key airports, leading to higher airfares on key routes as the CAAC abolished price ceilings on many top domestic routes in 2018. Given the slot constraints at Tier 1 airports, though, airlines are forced to grow more in lower-tier markets, resulting in lower average pax yields. James Teo’s top pick in China is Spring Airlines, the privately-owned leading Chinese low-cost carrier (LCC), which has high exposure to Japan/Korea routes that are extremely popular this year and is well-positioned to penetrate lower-tier markets effectively given their lower cost base. Air China and China Eastern Airlines, given their better quality domestic route networks and lower exposure to CNY depreciation and trade war.

LCC penetration rate is the highest in the Southeast Asia region at over 50%, hence competition is generally stiff, particularly in the low-cost segment, with AirAsia complaining of irrational pricing by competitors in Malaysia, although Cebu Air saw strong 6% RASK improvement in 2Q19 on the back of both average fare per pax and ancillary revenue growth.

Singapore Airlines reported strong 2.4% RASK improvement for its parent airline company on the back of strong premium cabin demand in its latest results for the April-June 2019 quarter, but its LCC arm, Scoot, reported an operating loss for the period due to a 2.1% RASK decline citing increased competition from Chinese airlines and higher costs on account of engine issues with its B787s. J.P. Morgan’s top pick in this space is Singapore Airlines, as the firm thinks its cost concerns should alleviate in the second quarter of 2019 as the B737 Max and B787 technical problems get resolved, with compensation from OEMs likely to follow after that, providing a possible catalyst. 

Russian air industry presents structural growth opportunities, Russia’s geographical position makes it an attractive transit point for flights between Europe and Asia, which underscores the potential for transit market development. Aeroflot cemented its leading position in the domestic market and has been the main beneficiary of sector consolidation over the last five years and its c40% market share makes it a quasi-monopoly.

Turkish Airlines provides an exciting growth story, in J.P. Morgan’s view, with planned capacity expansion outpacing global capacity build up by two times over 2018-2023. It aims to fill the network route gaps in fast-growing Emerging Asia while Turkish air market continues to offer secular structural growth story.

The company has been facing cost challenges this year which we expect to be resolved next year through better yields and growth. Despite these structural cost headwinds, the company still maintains its sub-bar cost base which makes J.P. Morgan confident that it will be able to retain its superior EBITDAR margins next year.

Darren Wood
By Darren Wood September 16, 2019 10:59