Wednesday's Top Upgrades (and Downgrades)

This series, brought to you by Yahoo! Finance, looks at which upgrades and downgrades make sense, and which ones investors should act on. Today, our focus is on airline stocks, as analysts at Dahlman Rose take an antiaircraft gun to pretty much every plane operator in sight.

We shrug to fly, and it shows
First off, Delta (Nasdaq: DAL  ) . From at least one perspective, investors and airplane passengers are natural enemies. On the surface, this seems clear, because when airline profits are high and investors love airline stocks, this generally means plane operators are charging higher ticket prices. But there are other permutations, less obvious.

Take "capacity reductions," for example. When an airline retires planes, and reduces routes, customers have to compete for fewer available seats. They bid up ticket prices, and often wind up paying too much for those infamous middle seats as well. But stock analysts? They love capacity reductions... for the same reasons the rest of us hate them. Given this, you'd think Dahlman would be thrilled to hear that Delta is cutting capacity by 2.6% this year, and a further 1% in 2013. But in fact, Dahlman's argument is that eventually, Delta must add back capacity if it wants to grow its revenues. Fearing the effect this will have on profits, Dahlman says Delta is only a hold.

Dahlman also assigned hold ratings to Republic Airways (Nasdaq: RJET  ) and United Continental (NYSE: UAL  ) this morning -- for completely different reasons. Republic, the analyst says, faces a squeeze from the major airlines whose hubs it feeds, as they attempt to "put pressure on the regional airlines by shifting around fleet types and demanding service." This will adversely affect profits -- and Dahlman points to recent bankruptcies at Pinnacle and American Eagle as the potential effect of this trend.

Meanwhile, StreetInsider.com says that Dahlman's downgrade of United Continental (also now a "hold") arises from the simple fact that the firm has mismanaged its integration of two major airline brands. The switch to a single reservation system for the combined airline "wreaked havoc on the system," with the result that many passengers have "chosen to fly other airlines."

So three airlines, and three hold ratings. Do any of them deserve better? Actually, maybe. Delta actually looks like the best bargain of these three airlines. It has the lowest P/E ratio (8.7) and the lowest forward P/E as well (3.2). What's more, according to most analysts, Delta is also growing fastest, with a projected per-year earnings growth rate of 38% over the next half-decade. Mind you, this prediction probably deserves to be taken with a grain of salt... but still, the other airlines' estimates are similarly high. All else being equal, Delta still looks like the best bargain of the three.

Delta's the best, but what of the rest?
Turning now to the airlines Dahlman loves to hate, SkyWest (Nasdaq: SKYW  ) and JetBlue (Nasdaq: JBLU  ) both got hit with downgrades to "sell" this morning. Why?

In SkyWest's case, the answer is a combination of factors already discussed above. On the one hand, SkyWest is expected to suffer from the same margin squeeze that has Dahlman feeling less than enthused about Republic. Additionally, the analyst sees Delta's desire to cut back on capacity as hurting SkyWest because "Delta will look to remove a large portion of SkyWest 50-seat operation is favor of larger 70-seat aircraft."

Meanwhile, JetBlue's problems are all its own. Founded in 1998, JetBlue isn't exactly an old company, but even so, Dahlman notes that the airline's fleet is "aging and is due for major maintenance causing a spike in this expense." Unfortunately for JetBlue, this need to upgrade the fleet comes just as the company's primary maintenance provider has filed for bankruptcy, and is busy liquidating operations. The loss of this key supplier has JetBlue scrambling to fill the gap, and paying above-market rates for the privilege.

Result: Even at 12 times earnings, JetBlue may not be as cheap a stock as it looks.

Fool contributor Rich Smith holds no position in any company mentioned. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


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