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JPMorgan says buy the dip in these airline stocks after the industry’s terrible earnings season

  • JPMorgan predicts the airlines' "return-oriented" management teams will maintain the industry's profitability going forward.
  • Airline stocks such as United Continental and Spirit Airlines fell more than 10 percent in the past month.
  • Investors are worried over United Continental's poor guidance, added capacity at Southwest and a pricing war between United and Spirit.

Airline stocks are tumbling this earnings season due to poor guidance and concerns over pricing.

One major Wall Street firm is telling its clients to buy the dip, predicting the industry's long-term positive fundamentals are still intact.

"Cost convergence, fare unbundling, widespread consolidation, diminished new entrant activity, and return-oriented management teams have combined to form an industry that is actually managing itself for the first time we can recall," JPMorgan analyst Jamie Baker wrote in a note to clients Tuesday. "We believe the U.S. airline industry will continue to take steps to ensure profitability and continued balance sheet repair."

Baker noted how airline names declined on a weak second-quarter earnings season with stocks such as United Continental and Spirit Airlines down more than 10 percent in the past month. He cited how investors are worried over United Continental's poor guidance, added capacity at Southwest and a pricing war between United and Spirit.

"Considering 10-15 percent pullbacks are of the magnitude that has reinvigorated interest in the past, it may be that lower entry points prove the next catalyst," he wrote.

As a result Baker raised his ratings on American Airlines and Spirit Airlines to overweight from neutral.

"American is in the midst of several revenue accretive initiatives including an expansion of Basic Economy and higher paid load factors in the domestic premium cabin, and we believe these initiatives will drive higher returns and stronger unit revenue," he wrote.

The analyst increased his price target on American Airlines to $61 from $52, representing 21 percent upside from Monday's close.

Baker also raised his 2018 earnings per share estimate for American Airlines to $6.20 from $5.47 versus the Wall Street consensus of $5.75.

Even though Spirit Airlines shares traded down 25 percent in the past month due to disappointing earnings results, Baker is confident the company will able to turn its business around.

"Spirit combines a favorable cost structure (labor, overhead, etc.) with targeting an underserved customer base that is more price sensitive than the typical legacy carrier flyer," the analyst wrote. "At current valuation levels, we view the market as being overly pessimistic given our positive view on CEO Bob Fornaro and a business model/strategy that can be repaired."

Baker lowered his price target for Spirit Airlines to $45 from $56, representing 16 percent upside from Monday's close.