American Airlines Stock: Why UBS Is Bearish

American Airlines (AAL) stock fell 3% yesterday after UBS analyst Myles Walton initiated coverage of the stock with a “sell” rating. His target price of $27 for the stock implies a 6% downside from yesterday’s closing price of $28.66.

Why Walton suggests selling American Airlines stock

Walton’s pessimistic view reflects his concerns about above-average capacity growth next year, reports Barron’s. The analyst thinks that the industry’s capacity could skyrocket once Boeing’s (BA) grounded 737 MAX aircraft returns to service.

Before the grounding in mid-March, there were around 390 MAX planes operating worldwide. Once Boeing gets recertification, which it expects shortly, over 300 more MAX planes will be ready for delivery. The resulting overcapacity could put pricing pressure on airlines.

Barron’s reports Walton expects capacity growth of 5% year-over-year next year, above the historical average. The analyst thinks that American Airlines may be more vulnerable to the MAX’s return than other US carriers. Currently, the airline has 24 MAX planes, and it was scheduled to receive an additional 16 this year.

Walton did, however, point out some benefits of the MAX’s return. According to Barron’s, he said the MAX’s reentry into American Airlines’ fleets would reduce its operating expenses. The analyst also thinks that the airline could gain market share.

Other analysts fear capacity growth risk, too

Walton isn’t the only analyst concerned about capacity after the MAX’s return next year. On September 23, Bank of America (BAC) analyst Andrew Didora warned of the risk of higher capacity next year. He expects that domestic seating capacity could rise by over 6% in 2020, in contrast with the 4% decline expected in 2019.

Therefore, he told investors to be more selective for airlines and to prefer companies with a better cost structure. For American Airlines stock, the analyst thinks that its high debt and ongoing labor dispute might pressure margins. Therefore, he downgraded it to “neutral” from “buy.” He also trimmed his target price for AAL by 18% to $31.

On October 31, Bernstein analyst David Vernon cited similar reasons for his rating downgrade for Southwest Airlines (LUV). The low-cost carrier owns 34 MAX aircraft and is scheduled to receive an additional 70 next year. Having over 100 jets in its fleet would increase its overall capacity drastically, pressuring airfares.

These analysts’ forecasts suggest airlines’ problems won’t fade with the MAX’s return. MAX customers are facing massive flight cancellations and capacity losses due to the grounding. To learn more, read Boeing MAX Grounding Costs US Airlines $1 Billion.

Analysts’ recommendations

American Airlines has struggled to keep up with rivals this year. At the start of the year, analysts were optimistic about the stock. However, the company’s exposure to Boeing’s MAX, high debt, and labor disputes have cast shadows on its growth prospects.

At the beginning of the year, about 74% of analysts covering AAL suggested “buy,” and the remaining 26% suggested “hold.” Now, only 52% of analysts suggest “buy,” while 19% suggest “sell.” The remaining 29% suggest “hold.” Their average target price of $36.26 is 20% lower than at the beginning of the year.

American Airlines stock’s performance

Among the top four US air carrier stocks, American Airlines has been the weakest this year. The stock has fallen approximately 11% year-to-date, losing $1.5 billion of its market capitalization. At yesterday’s closing price of $28.66, the stock was trading near its five-year low of $24.23 on August 28. It was 51% below its five-year high of $59.08 and 35% below its 52-week high of $43.89.

This year, AAL peers Southwest, Delta Air Lines (DAL), and United Airlines (UAL) have gained 24%, 13%, and 10%, respectively. AAL stock has also underperformed broader markets and the iShares Transportation Average ETY (IYT). The Dow Jones, S&P 500, and IYT are up 19.1%, 23.4%, and 18%, respectively, year-to-date.