Annualized industry fuel costs have declined ~$5.5 billion in recent weeks, yet estimates have barely budged while equities have suffered. JPM believes early June will be characterized by several rounds of upward revisions, likely one of the few sectors so fortunate. Estimate revisions are expected to prove particularly robust for LCC, given its lack of fuel hedges and limited European exposure.
Remain bullish on the space – The broader thesis is unchanged; manageable fuel, tight supply, incremental revenue streams, disciplined managements and rapidly recovering demand portend a multiyear profit run for U.S. operators, in their view. Add to this the recent decline in equities (CAL & AMR recently triggered “Down 30 in 30”) and the fact that all Legacies & Discounters are trading <5x style="font-weight: bold;">
Figured they’d go first – Despite the ~$5.5 billion in recent industry fuel savings, estimates have barely budged. They’re not sure why, though they believe others may be awaiting the release of May traffic data. Thus, the first two weeks of June are likely to be characterized by several emails hitting investors’ inboxes, largely echoing their thoughts from today.
One of three outcomes is likely – Raising estimates by the full $5.5 billion seems aggressive, as it ignores the potential for softer demand. Lowering fuel and revenue by a like amount – hence leaving estimates unchanged – similarly seems aggressive, as the removal of $5.5 billion of revenue would imply GDP slips by over 2%. They’ve therefore elected the middle ground.
2010/2011 estimates raised – JPM's 2011 industry operating profit rises by $2.7 billion to an all-time record $13.4 billion, reflecting the combination of lower fuel and slightly softer revenue. Improvement in 2010 is not as material, given changes are largely to 2H10 and fuel hedges diminish some of the benefit. They now stand above consensus for every U.S. airline they follow.
LCC should thrive in this environment – The dust seems to be settling around the rhetoric of LCC being “frozen out” by industry consolidation (never JPM's view). Turning back to fundamentals, LCC’s lack of fuel hedging results in one of their largest upward estimate revisions (2011 $2.08 to $3.68 vs. $1.94 consensus). Additionally, while they aren’t expecting any pronounced decline in transatlantic demand, LCC’s exposure is the lowest of any Legacy at 12% of system revenue vs. ~20% for others. Their changes propel their earlier $8.50 target to $11.50, prompting an equity upgrade from Neutral to Overweight.
While Europe has proved the catalyst for the market’s recent correction, they do not believe demand to be particularly jeopardized. JPM estimates that U.S. point of sale generates 75% of U.S. Legacy demand to/from Europe (including the domestic portion of the journey), with only 25% coming from Europeans themselves. Put differently, they doubt many Germans start their day by declaring "Ich muβ einfach nach Amerika kommen! Wie ist die Telefonnummer von US Airways.”
For this reason, the increased affordability of Europe may actually cause total demand for U.S. Legacies to rise, while the opposite may occur to their European peers. That said, should current European dislocation ultimately impact financial services (a disproportionate consumer of aircraft between here and there), the impact would likely be felt by U.S. operators.
Notablecalls: JPM is the Airline powerhouse - their team is very well respected & influential.
I would not be surprised to see LCC trade green today, even in this horrific tape.
2011 EPS of $3.68 vs. $1.94 consensus. Wow.