City downgrades hammer these airline stocks

Not much is going right for these carriers, and now the analysts are cutting their number again. 

Airline valuations continue to be ruled by fear, a leading analyst said today as more City downgrades kept International Consolidated Airlines Group SA (LSE:IAG) and easyJet (LSE:EZJ) at levels seen in the depths of the pandemic.

Liberum’s Gerald Khoo regards the carriers as “long-term structural winners” and is surprised at their current positions, particularly given that the challenges facing the industry today appear modest when viewed against the peak of Covid disruption.

He said: “The long-term outlook is materially better now than two years ago, but this is not reflected in share prices.”

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Khoo has “buy” recommendations on both airlines but has lowered his price targets on IAG from 200p to 145p and easyJet from 500p to 460p in order to reflect changes in the economic outlook and fuel prices.

In today’s downbeat London session, the pair were at or near their low point for the past year as IAG shares shed 2p to 106p and easyJet lost another 11.3p at 342.3p.

The selling came as analysts at Stifel halved their price target on the FTSE 250-listed budget carrier to 300p and removed their “buy” recommendation.

Shares in easyJet had been above 700p in February amid optimism over a post-Omicron rebound for the industry, but these hopes have been derailed by the Ukraine war, soaring fuel prices and now the threat of recession and fears over weaker consumer demand.

The industry disruption caused by staffing shortages in the summer has abated and while fuel prices are still high, there are signs that these may fall as the global economy cools.

Overall, air traffic activity is still expected to return to pre-pandemic levels by 2024 but with variations by region and route. In today’s note, Khoo said he expects intra-European routes to recover faster than average, with Europe to Asia Pacific routes likely to lag.

Khoo said: “Ultimately, demand ought to remain resilient and short-term industry challenges should drive rationalisation of marginal players and capacity. Current valuations appear ruled by fear, leaving long-term upside opportunities.”

He believes easyJet has done much to improve its cost base and strategic position through the pandemic, including the expanded use of seasonal contracts that should moderate winter losses.

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Two equity issues have reinforced the balance sheet and Khoo believes a current valuation of 11.7 times calendar 2023 earnings does not recognise strategic progress.

He added: “IAG is the least consensual call, although the majority of analysts retain positive recommendations.

“In our view, its higher leverage makes it higher risk, especially if the winter brings another surge in Covid infections or new variants that trigger renewed international travel restrictions.

“Nonetheless, we believe the pandemic will not have a persistent adverse impact on IAG’s long-term profitability.”

Khoo adds that a current valuation of 8.9 times 2023 earnings fails to take into account IAG’s ability to return to delivering higher margins than its network carrier peers.