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JPMorgan: Rest of Wall Street has no idea how badly a pricing war is hurting airline earnings

  • JPMorgan analyst Jamie Baker slashed fourth-quarter estimates by 60 percent for both United Continental and Spirit Airlines.
  • The researcher explained that he now forecasts just a 64 cents profit at United Continental against consensus estimates of $1.41.
  • Since 2016, airline companies have been lowering prices to keep up with Spirit and Frontier Airlines, both of which offer no-frills flights for significantly lower fares.
Passengers use self check-in kiosks inside the United Continental Holdings Inc. terminal at Newark Liberty International Airport (EWR) in Newark, New Jersey, April 12, 2017.
Timothy Fadek | Bloomberg | Getty Images
Passengers use self check-in kiosks inside the United Continental Holdings Inc. terminal at Newark Liberty International Airport (EWR) in Newark, New Jersey, April 12, 2017.

JPMorgan issued major reductions to earnings forecasts on U.S. airline companies Friday, warning that reluctance to raise fare prices is hamstringing profits.

"The market may not be prepared for the severity of our fourth-quarter cuts," wrote analyst Jamie Baker. "We continue to pour over fare filings in hopes of identifying evidence of renewed domestic pricing vigor."

The analyst slashed fourth-quarter estimates by 60 percent for both United Continental and Spirit Airlines, arguing that low prices are jeopardizing profits.

Baker explained that he now forecasts just a 64 cents profit at United Continental against consensus estimates of $1.41, while projecting a 34 cents profit at Spirit versus consensus of 60 cents. His research largely blames airline management's hesitation to adjust prices upward.

"We remain convinced that if/when we can point to any substantive efforts – particularly if originating at United Continental or Spirit– investor sentiment will quickly swing to the upside and our consensus-busting earnings forecasts may well enjoy the potential to rise."

Since 2016, airline companies have been lowering prices to keep up with Spirit and Frontier Airlines, both of which offer no-frills flights for significantly lower fares. These newcomers are able to generate demand from more choosy fliers, who may be turned off by the steep prices major airline mergers tend to create. They also force other airlines to rein in fares.

For example, JetBlue temporarily capped its prices in Florida at $99 for direct flights last week to help costumers evacuate ahead of Hurricane Irma. Other major airlines had introduced steep price increases as demand for tickets soared.

That decision seemed to force other airlines to follow suit. American announced last Wednesday that it would also cap fares at $99 for coach seats.

But now that the natural disaster is over, Baker says it's time to go back to the drawing board.

"Recall we recently grabbed for the falling Spirit Airlines knife," continued the analyst. "But since the time of our upgrade, Spirit management has shown little interest in making course corrections, in our view, and has continued to expand sub-$20 fares even in the hours leading up to its recent earnings warning."

JPMorgan's analyst downgraded both United Continental and Spirit to neutral, and sliced its December 2018 price target for Spirit to $37, representing an anemic 6 percent upside from Thursday's close. Its new December 2018 target for United Continental is $68, representing just 11 percent upside over the same time.

American Airlines fared little better.

"We've been disappointed by the lack of pricing vigor that American has displayed in recent weeks," added Baker. "Pricing discipline is core to the bull investment case for legacy airlines like American, and we have not yet seen meaningful self-help initiatives."