What happened
On Wednesday, a pair of airline stocks were downgraded by a leading Wall Street analyst. The whole sector is selling off as a result, with shares of American Airlines Group (AAL 2.42%), JetBlue Airways (JBLU 1.08%), and Spirit Airlines (SAVE +0.00%) leading the way down about 5% each in midday trading.
So what
Airline stocks have experienced some turbulence of late, caught between investors bullish on a post-pandemic economic recovery and those who are worried about whether the pandemic is really over, among other issues. On Wednesday, the bears are in charge after Goldman Sachs downgraded both American and JetBlue.
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Goldman's Catherine O'Brien downgraded JetBlue to neutral from buy and cut her price target to $17 from $20. In an accompanying note, O'Brien said she remains positive the airlines are on the path to a recovery but is worried fourth-quarter results and the 2022 outlook could be put under pressure due to higher fuel costs and an uncertain revenue environment.
O'Brien also took American to a sell from a neutral and cut that airline's price target to $18 from $19. American, she notes, has "relatively higher" operating leverage than its rivals, and that will eat into profitability as conditions slowly normalize.
In short, the analyst is predicting that over the near-to-medium term, cost pressures are likely to outrun pricing power, putting pressure on results. That is likely to continue until corporate travel returns, which is not expected to happen in earnest until 2022 at the earliest.
Those concerns can easily be translated to the entire airline sector, and Spirit, which is viewed as a likely beneficiary of a quick recovery, is being hit particularly hard. Delta Air Lines (DAL +1.45%) was off about 2.5% after it too was the target of a downgrade, with Wolfe Research lowering the shares to peer perform from outperform on valuation.
Now what
Overall, Goldman's O'Brien remains upbeat that the airlines are recovering. The issue is the timing. Her logic is hard to argue with.
For those with a long-term mindset and who are willing to hold through whatever headwinds might lie up ahead, there is nothing in this research that should be cause for panic. The U.S. aviation sector has shown surprising resiliency through the pandemic crisis and is well positioned to hold on now through whatever COVID variants or other unexpected twists might lie ahead.
Given the risks, I believe it is best to focus on best-of-breed operators with superior balance sheets like Delta and Southwest Airlines (LUV +0.36%). Airlines might take investors on a wild ride in the months to come, but the long-term future for the sector looks a lot better now than it did in the early days of the pandemic.
