2025 Airline Outlook_ Year of the Underdogs

Summary of Airline Industry Research Call Industry Overview - The airline industry is expected to experience improved profitability in 2025 due to capacity discipline and margin differentials between leaders and laggards [1][2] - The US Airlines JETS ETF has gained 45% since August, reflecting a positive market sentiment [2] - Capacity growth for Q4 2024 is projected to increase by 2.0% year-over-year in seats and 1.9% in available seat miles (ASMs) [2] Key Financial Metrics - Airlines have re-rated their FY2 EBITDA by approximately 1X since August, with a current average multiple of ~6X, compared to a pre-pandemic standard of ~7X [5] - The discount to the S&P has narrowed from 65% to 60%, indicating a potential for further re-rating [5][27] - Average operating margin expansion of 90 basis points is estimated for 2025, despite challenges in cost management [3] Company-Specific Insights - United Airlines (UAL): Remains a favored long-term investment with visibility to low double-digit pre-tax margins. The stock is rated as a Buy with a price target of $132 [6][7] - American Airlines (AAL): Upgraded to Buy with a price target of $20, expected to recover from a $1.5 billion distribution hole in 2024. Projected EPS for 2025 is $2.55, a 14% increase from consensus estimates [6][7] - Delta Air Lines (DAL): Rated as Buy with a price target of $76, focusing on reducing gross leverage to 1X and generating $3-5 billion in free cash flow (FCF) annually [4][42] - Southwest Airlines (LUV): Rated as Hold with a price target of $34, focusing on a $2.5 billion share repurchase program [4][43] - Air Canada (AC): Rated as Hold with a price target of C$23, planning to re-lever its balance sheet for share repurchases [4][44] Capacity and Growth Projections - Total ASM growth for 2025 is expected to be around 2.5%, with DAL and UAL leading with 3-4% growth [18] - Low-cost carriers (LCCs) are expected to face challenges in maintaining market share without aggressive pricing strategies [17] - The industry is projected to return to typical mid-single-digit growth rates in air traffic, with normalized demand expected to fill capacity gaps [53][56] Cost Management and Profitability - Cost pressures are anticipated to persist, with CASM-ex expected to increase by 3.6% year-over-year in 2025 [3][38] - Airlines are implementing cost-out initiatives, with AAL targeting $1 billion in savings by 2026 [36] - Maintenance costs remain elevated, approximately 40% above pre-pandemic levels, impacting overall profitability [19] Capital Allocation Strategies - Airlines are adopting varied capital allocation strategies, with some focusing on debt reduction while others prioritize shareholder returns [10][39] - UAL is noted for its shareholder-friendly approach, planning significant share repurchases funded by FCF [45] - AAL is focused on deleveraging, aiming to reduce its debt significantly by 2028 [41] Conclusion - The airline industry is positioned for a recovery in profitability driven by capacity discipline and strategic capital allocation. Key players like UAL and AAL are expected to lead the way, while cost management remains a critical focus for all carriers. The potential for further re-rating exists as the market stabilizes and demand normalizes.