If there was a theme to the downgrades, it was that investors are getting tired of weak unit revenue performance across the airline industry. The analysts, fearing this negative sentiment, downgraded the stocks, thus adding to the negativity!
At a superficial level, this has created a vicious cycle for the airlines. Even JetBlue and Alaska -- two of the best performing airline stocks -- are now being undercut by this negative sentiment. But unlike a true vicious cycle, which would actually damage the underlying businesses, this feedback loop only impacts the stocks. That's creating great opportunities for patient investors willing to wait out the "negative sentiment."
JetBlue: 1% is not enough!
JPMorgan's downgrade of JetBlue (from overweight to neutral) was perhaps the most bizarre. That's because JetBlue has been one of the few airlines bucking the trend of falling unit revenue this year. Nevertheless, analyst Jamie Baker cut his rating on JetBlue, arguing that a combination of weak unit revenue growth and a lack of "catalysts" make the stock unappealing at its current price.
It's true that JetBlue's unit revenue for Q3 will be roughly flat year over year. But that's a great result given that unit costs will be down by double digits thanks to the collapse of jet fuel prices in the past year. Furthermore, JetBlue's capacity rose 10.4% last quarter, so JetBlue is still posting strong revenue growth even with flat unit revenue.
There also seem to be plenty of earnings growth drivers coming in the next few years, which I detailed recently. Even before its 8% fall on Tuesday, JetBlue stock traded for a modest 12 times forward earnings, which seems quite low for a company with ample growth and margin expansion opportunities.
American Airlines: too much competition
There's more of an argument to be made for Evercore ISI's downgrade of American Airlines. The combination of the strong dollar, falling international fuel surcharges, and rising competition in Dallas and Chicago caused passenger revenue per available seat mile (PRASM) to decline 6.9% in Q2. American has also estimated that PRASM fell 6%-8% in Q3.
Analyst Duane Pfennigwerth was most concerned about American Airlines' efforts to match the prices of ultra-low cost carriers. According to Pfennigwerth, not only does this make investors more nervous about the industry's long-term pricing power, it also could damage the brand by cheapening it.
However, it's hard to see why business travelers who pay up for premium seats would care much about the prices for cramped seats at the back of the plane. Moreover, American Airlines stock trades for just five times projected 2015 pre-tax earnings (eight times earnings after tax), implying that investors now have very low expectations for the company.
Thus, the stock is so cheap that long-term investors are likely to be well-compensated for their patience. In the meantime, American Airlines is buying back shares at a furious pace to take advantage of the low stock price, further supporting its EPS growth.
Alaska Air: too expensive?
Pfennigwerth didn't have any particular complaints about management's strategy at Alaska Airlines. Nevertheless, he downgraded the stock to hold from buy on valuation concerns.
Indeed, Alaska (like JetBlue) is at the higher end of the typical valuation range for airlines. It has been trading for about 11 times forward earnings estimates lately. It's also true that Alaska Airlines doesn't have the same kind of margin expansion drivers that exist at JetBlue right now. (That's largely because Alaska already has a best-in-class profit margin.)
On the other hand, Alaska Airlines is also a relatively small airline with plenty of long-term growth opportunities. It has increased capacity by 10% year to date, contributing to its expected EPS growth of more than 50%. Alaska Air also has a stellar balance sheet, allowing it to buy back lots of stock to juice its EPS growth. Given all of these positives, 11 times forward earnings doesn't seem very expensive at all.
The supposed problems at all three airlines are really just a matter of perception. All three are on pace to post dramatic earnings growth this year. Yet American Airlines stock is dirt cheap, while JetBlue and Alaska Air aren't being valued as the growth companies they are. Sooner or later, the stocks should catch up to reality, offering big potential gains for long-term investors.
Adam Levine-Weinberg is long January 2017 $17 calls on JetBlue Airways and long November 2015 $40 calls on American Airlines Group. The Motley Fool is long January 2017 $35 calls on American Airlines Group. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.