uploads/2017/11/Valuation-10.png

Airlines’ Relative Valuation after 3Q17 Earnings: What Is Priced In?

By

Updated

Current valuations

Southwest Airlines (LUV) currently has the highest forward EV-to-EBITDA[1. enterprise value to earnings before interest, tax, depreciation, and amortization] multiple of 6.9x among its peers. American Airlines (AAL) and Alaska Air Group (ALK) each have a similar valuation multiple of 6.4x.

Spirit Airlines (SAVE) has a multiple of 6.2x, while JetBlue Airways (JBLU) is valued at an EV-to-EBITDA multiple 6.1x. Delta Air Lines (DAL) is trading at a valuation multiple of 5.7x, and United Continental (UAL) has the lowest multiple of 5.3x.

Our analysis

The airline industry is highly competitive with little brand loyalty. Customers are price sensitive and usually go to the airline offering the cheapest flight.

The industry also requires regular and high injections of capital, making it difficult for investors to earn returns. Lastly, two of its biggest costs—labor and fuel—are beyond its control.

However, the landscape started to improve when crude oil prices declined in mid-2014, which reduced airline fuel costs substantially. Also, investor consolidation occurred in the industry, with top airlines being held by common investor groups, led to the belief the scenario could improve. Airlines would refrain from unrestrained capacity growth, which could subdue the airfare wars.

However, in the last year, this scenario has not materialized. Airlines’ 2017 capacity growth has been much higher than expected, and their 2018 targets appear to point toward a continuing trend.

Airfare wars have plagued the industry in many markets, leading to declining yields and unit revenues for most airlines. As a result, airline stocks have suffered.

In our view, investors should watch the excess capacity in the industry and the intensifying airfare wars. Economic growth is a key growth driver, which should also be closely tracked.

We provide regular updates on these issues. For more information, please visit Market Realist’s Airlines page. You can gain exposure to airline stocks by investing in the iShares Transportation ETF (IYT), which invests ~20.0% in airlines.

More From Market Realist