A prominent analyst just issued an upgrade of Southwest Airlines (LUV -0.55%), and his rationale has the whole sector taking flight. Shares of Southwest, Delta Air Lines (DAL 0.20%), United Airlines Holdings (UAL 2.56%), and JetBlue Airways (JBLU 0.88%) were all up more than 5% on Friday morning on commentary that the post-pandemic aviation recovery is far from over.
It's been a turbulent few years for airline stocks, with shares initially hit hard by the pandemic on fears that the drop in travel demand would lead to a rash of airline bankruptcies. But in the U.S., the industry was able to fly through the storm better than expected, and as the vaccines began to roll out, the airlines were part of the so-called "reopening rally" earlier this year.
The stocks have mostly gone sideways for a few months now, caught up in a battle between bulls who see significant pent-up demand and bears who worry about added debt taken on during the crisis alongside issues including the Delta variant and continued sluggish demand for business and international travel.
But JP Morgan's Jamie Baker thinks the concerns are overblown. On Friday, Baker upgraded Southwest from neutral to overweight and raised his price target to $70 from $64.
Baker's reasoning is resonating with investors in several airlines. The analyst wrote airline stocks have "room to run," citing "encouraging" JP Morgan internal travel spending data and the recently announced easing of U.S. border restrictions. This remains a domestic-fueled rally, Baker said, but European travel is beginning to spring to life and there are also signs of improved bookings on the all-important New York-London route.
Baker only upgraded Southwest, but it is easy to see why the commentary is moving the entire sector. The bullishness goes far beyond the operations of one airline. Southwest, for example, doesn't even fly to Europe.
Of course, many risks remain. There is reason to hope the worst of the Delta variant is behind the U.S., but we don't know what might come next from the pandemic and how these developments might impact the quarters to come. And there are some encouraging signs that historically more lucrative segments of the market like business and international travel might be off of their lows. Still, many corporations won't even require employees to return to the office until 2022. Therefore, it is hard to imagine a quick spike in the travel business any time soon.
Valuations are reasonable, but uncertainty remains. I agree with Baker's overall optimistic tone, but investors should be aware that this is unlikely to be a straight shot higher and that risks are still in play. For those willing to buckle up for some turbulence and buy right now, it is best to stick with top-quality operators like Southwest and Delta.