Cowen downgrades JetBlue, American and United on rich valuations

Published Wed, Jan 4 201711:44 AM EST

Valuations for airlines stocks reached new highs after the U.S. presidential election, a reason why investors should lower exposure to the sector, according to Cowen, which downgraded JetBlue , American Airlines and United Continental to market perform from outperform. "Airline shares and multiples were up ~29 percent and ~37 percent in 4Q16 [fourth quarter] as demand and business yields improved post the U.S. presidential election. The share gains are the result of multiple expansion and not earnings improvement," equity analyst Helane Becker wrote in a note to clients Wednesday. Becker believes slowing capacity growth in 2017, along with margin compression due to higher jet fuel and labor costs could impact earnings. "The market has not cared about increased costs and focused only on improving unit revenue trajectory. We believe investors will look to rising costs in 2Q17 [second quarter] once unit revenue is on a positive path," Becker said. Since the U.S. presidential election on Nov. 8, earnings multiples for the airline group have increased by more than 20 percent to 12.4, according to Cowen's estimates. Given the sharp rise in multiples, Cowen believes the upside potential for the group is limited, and could hence lead to a bumpy ride for these stocks, at least in the near term. "We expect investors will look for the next issue to nitpick. We believe that issue will be margin compression due to higher jet fuel and labor costs. If we were to couple recent multiple expansion with our view of margin compression, and a potential stumble on unit revenue, we believe there is more downside than upside over the next six months," Becker said. Cowen forecasts U.S. airline carriers will experience a slowdown in capacity growth in 2017 to 2.5 percent from 3.5 percent in 2016. The majority of that growth will come from domestic markets, while international markets will remain challenged due to increased competition. "The most concerning region for the U.S. airlines is clearly the Atlantic," said Becker, who believes the market is "oversaturated" with low-cost carriers. "If Latin America is any indication for how long this region could struggle we believe we are in the early innings of unit revenue deterioration and capacity concerns in that region," she said. As a result of this trend, Cowen also downgraded Alaska Air and Spirit Airlines to market perform from outperform. "We believe the airline industry can continue to rerate higher, but given the sharp move in multiples in 4Q16, the stocks will likely take a breather first," Becker said.

A JetBlue Airways Corp. plane taxis past an American Airlines plane at LaGuardia Airport in New York.

Scott Eells | Bloomberg | Getty Images

"Airline shares and multiples were up ~29 percent and ~37 percent in 4Q16 [fourth quarter] as demand and business yields improved post the U.S. presidential election. The share gains are the result of multiple expansion and not earnings improvement," equity analyst Helane Becker wrote in a note to clients Wednesday.

Becker believes slowing capacity growth in 2017, along with margin compression due to higher jet fuel and labor costs could impact earnings.