Disagreeing With Analyst Downgrade on US Airways

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Even with a fundamental shift in the airline sector, analysts are quick to downgrade US Airways Group (NYSE: LCC) at market low earnings multiples. Sure the airline industry has historically struggled to make profits, but the recent consolidation provides hopes for a liberated industry.

The company operates more than 3,100 flights per day and serves 198 communities around the globe. US Airways expects to close the merger with AMR Corp. (NASDAQOTH: AAMRQ.PK) in the third quarter to become the largest domestic airline. The stock, though, was down around 6% at the lows of the day based in large part on the downgrade.

Analyst downgrade

Bank of America downgraded shares of US Airways and lowered the price target on the stock to only $16. The analyst placed an underperform rating on the stock based on concerns that the proposed merger with AMR wouldn’t produce enough synergies in the short-term to justify a higher price.

One important factor to note when reviewing an analyst position is whether the previous prediction was accurate. Note that the analyst was previously neutral on the stock while it soared to $19.70 prior to the recent sell-off. Any analyst neutral or negative on the stock missed a significant run over the prior months. In reality, this downgrade didn’t change negative opinion by the analyst. If an investor believes in the story, this opinion shouldn’t be followed.

Best load factor for May

The intriguing part of the downgrade is that US Airways reported a record load factor in May of 85.8% for mainline passenger traffic. The figure was up 1.7 points versus last May. More importantly the revenue passenger miles increased by 5.9% compared to the 3.9% increase for the available seat miles.

Most of the May and year-to-date traffic numbers at US Airways and other airlines continue to suggest a major shift in the airlines focus away from market share towards profits.

Cheap earnings multiple

Clearly the market doesn’t fully believe in the airline industry yet. The stocks trade at some of the lowest multiples in the market by far. With the market approaching PE multiples of around 16, the top airlines all struggle to reach 6.

US Airways trades at 5.5 times forward estimates yet the analyst placed an underperform on the stock. Fellow industry behemoths Delta Air Lines (NYSE: DAL) and United Airlines (NYSE: UAL) trade at multiples closer to 6 times forward earnings.

With the consolidation in the industry and plans by Delta to legitimately return capital to shareholders, it seems unreal that investors are willing to unload the airline shares at such low valuation multiples.

Analysts expect earnings to surge at Delta, reaching over $3 in 2014 from earnings of just $1.88 in 2013. Revenue growth should be limited, but the company will be able to drive margins from less competitive pricing.

Analysts expect United Airlines to see earnings jump to $4.91 in 2014 from $3.65 this year. Trading at $31, the stock is extremely cheap based on any valuation analysis assuming the industry has moved away from the market share focus.

Bottom line

When most slow growth sectors such as utilities trade at earnings multiples of double that of airlines, investors should consider rotating sectors. Clearly the airlines have a history of disappointing the market, but the tide appears to have shifted with this last consolidation of AMR into US Airways.

Based on the May load factors and cheap earnings multiples, the analyst downgrade of US Airways appears to provide a great buying opportunity instead of a reason to panic.

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Mark Holder and Stone Fox Capital Advisors, LLC have no positions in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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