Good times for airline stocks appear to be over

Published Tue, Oct 13 201512:26 PM EDT

Airline stocks, as measured by the S & P Airline Index, quadrupled from the start of 2012 to a 13-year high reached in January on a perfect mix of falling jet fuel prices and a rising economy. Industry profit margins at 17 percent are at a record, according to JPMorgan. "Airline equities continue to screen well on metrics that typically matter: return on invested capital, low valuations, margin expansion, free cash flow, you name it," Jamie Baker of JPMorgan wrote in a note to clients Tuesday. He added, "The industry has never been this prosperous nor better able to weather exogenous shocks, in our view." But even as energy prices have continued their decline in 2015, the stocks are starting to show cracks. The airline Index is down 10 percent this year with American Airlines down 19 percent and United Continental down 14 percent. Analysts fear that for the once perennially plagued industry, this is as good as it will ever get. Here is what they said... "Where's the revenue vigor? Industry domestic revenue is contracting, despite GDP and consumer trends that aren't uniquely poor. While currency, fuel surcharges, and sluggish economic trends help explain international weakness, there's only one thing we can cite to explain what's happening at home: gratuitous discounting," Baker wrote in the report. Read More The force is with these 'Star Wars' stocks He added, "Until managements take a more aggressive approach to shoring up the top line, equity upside may be difficult to achieve." Baker is revising lower his 2016 revenue per available seat mile (RASM) estimate from plus 1.3 percent to minus 2 percent. He states many of clients are increasingly frustrated and believes that stocks will likely remain cheap until RASM metric improves. The analyst also downgraded shares of JetBlue Tuesday. Duane Pfennigwerth of Evercore ISI sees margin compression in 2016 as oil prices stabilize and ticket discounting continues. "While airline margins continue to improve significantly year over year in third quarter 2015, higher assumed fuel in 2016 ($65 Brent) implies modest margin compression for most U.S. airlines," Pfennigwerth wrote in the note to clients Tuesday. Read More Who's next after Yum, NuSkin China shockers? He specifically calls out American Airlines as the discounting offender and downgraded shares of the airline Tuesday. "American's blunt price competition with ultra-low cost carriers makes it harder to convince those investors the industry has fundamentally changed... . We believe American is commoditizing its brand and losing hard-earned pricing segmentation," Pfennigwerth states in the note. It may be prudent for investors to avoid the airline sector until pricing improves and worries about a future fall in profit margins dissipate.

American Airlines planes and passengers at the Dallas/Fort Worth International Airport.

Scott Mlyn | CNBC

Airline stocks, as measured by the S&P Airline Index, quadrupled from the start of 2012 to a 13-year high reached in January on a perfect mix of falling jet fuel prices and a rising economy.

Industry profit margins at 17 percent are at a record, according to JPMorgan.

"Airline equities continue to screen well on metrics that typically matter: return on invested capital, low valuations, margin expansion, free cash flow, you name it," Jamie Baker of JPMorgan wrote in a note to clients Tuesday.

He added, "The industry has never been this prosperous nor better able to weather exogenous shocks, in our view."

But even as energy prices have continued their decline in 2015, the stocks are starting to show cracks. The airline Index is down 10 percent this year with American Airlines down 19 percent and United Continental down 14 percent.

Analysts fear that for the once perennially plagued industry, this is as good as it will ever get.

Here is what they said...