Rating downgrade

American Airlines (AAL) stock fell nearly 3% on May 20 after Morgan Stanley (MS) downgraded the stock to “underweight” from “equal-weight” and trimmed the target price by $14 to $26. The research firm warned that the company has the highest labor risk among US airlines, which could lead to an increase in its labor and overall costs.

Morgan Stanley Changed Its Ratings on These Three Airlines

Morgan Stanley analyst Rajeev Lalwani in a note to clients stated that American Airlines would have to renegotiate labor contracts with approximately 70% of its workforce in the next six to 18 months. He believes that the renegotiations would increase cost troubles for the company, which is already facing higher fuel, fleet, and airport landing prices.

Lalwani in his note warned that “AAL faces the most labor risk within the group, which we assume will be reset higher over the next 6- 18 months and drive CASM-Ex Fuel up 2.5-3.5% on average between 2019/2020, and further compounded by jet fuel prices rising ~10% next year per forwards,” CNBC reported.

Given the factors mentioned above, the analyst foresees considerable downside risk to the 2020 consensus EPS estimate. Analysts polled by Reuters have provided a consensus 2020 EPS estimate of $5.71. Lalwani further elaborated his target price calculation and said, “When applying P/Es consistent with the last ~5 years at ~7.5x on 2020, shares have downside potential of ~18% per our updated PT of $26 (vs. $40 prior).”

Lalwani view on AAL’s peers

Lalwani also downgraded Delta Air Lines (DAL) to “equal-weight” from “overweight,” citing concerns over its elevated capital expenditure and falling free cash flow yield. The analyst also pointed out that the stock currently trades at a premium valuation to the majority of its peers and has reached a mature valuation. He also cuts his target price on the stock to $61 from $62.

On the contrary, Lalwani liked United Airlines’ (UAL) mid-US expansion plan executions, which he believes is well reflected in the company’s financial results. He also believes that the company will continue to benefit from its cost containment and loyalty programs. Therefore, Lalwani upgraded the stock to “overweight” from “equal-weight” and increased the target price by $9 to $110.

Investors can get exposure to US airline stocks by investing in the iShares Transportation Average ETF (IYT), which has allocated 16.7% of its funds in the passenger airline industry. The ETF has gained 14.2% in the year so far and had outperformed the Dow Jones and the S&P 500, which are up 10.1% and 13.3%, respectively.

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