City's favourite airline shares about to take off

There's reason to be optimistic about the airline sector reckons one City big hitter. These are the stocks they like most. 

Fears of more turbulence in the airline sector in 2023 were countered today when a City bank swung behind the shares of International Consolidated Airlines Group SA (LSE:IAG) and Wizz Air Holdings (LSE:WIZZ)

Bank of America believes scope for their return to pre-pandemic levels of cost controls and margins can offset the recession outlook and concerns about balance sheet strength.

IAG’s shares were among the best performing in the FTSE 100 following today’s “buy” upgrade, meaning they’ve risen by a third since improved guidance in third quarter results.

• Find out about: Transferring a Stocks & Shares ISA  | Share prices today | Top UK shares

Wizz is up by 77% since mid-October and well ahead of the 33% improvement of rival easyJet (LSE:EZJ). The Luton-based carrier was today downgraded to “underperform” by Bank of America due to it being the only stock where unit costs are set to remain above pre-pandemic levels.

The bank’s analysts are also cautious on Air France-KLM (EURONEXT:AF) but Dublin-based Ryanair is retained at “buy” due to its quality, growth and market share gains, while Lufthansa has been raised to “Neutral” given Asia exposure and potential asset sales.

Airline shares in Europe are down by an average of 20% year-to-date, underperforming the Stoxx 600 by 10% due to demand fears and the impact of surging jet fuel prices.

Bank of America said: “Although a recession could negatively impact pricing and profitability in 2023, we think investor positioning is very bearish and is likely to drive potential outperformance.”

The bank is optimistic that a rebound in capacity and revenues will continue in 2023 as more Asia destinations reopen and the still-nascent corporate travel recovery adds to strong levels of transatlantic activity.

It believes demand could surprise positively and expects revenues to have recovered to 95% of 2019 levels in 2022, rising to about 110% next year.

Rising costs are a headwind as airlines face higher wages, airport fees, air traffic control and ownership costs. However, the bank expects unit costs excluding fuel to decline year-on-year in 2023 as capacity recovers.

Margins are likely to remain below pre-pandemic levels next year, but with a potential full return to profitability expected in 2024.

Leverage is a concern as IAG and Wizz have the highest debt to earnings ratios, but the bank believes ample liquidity means the risk of a rights issue is low.

Its “buy” recommendation on IAG highlights the potential for shares to reach 200p, driven by expectations for underlying earnings growth as unit costs normalise and capacity ramps up.

• Investor poll: fears, predictions and strategies for 2023
• Why this bear market rally may have further to go

IAG had the best cost control and margins among the network carriers pre-pandemic, meaning it should benefit as the traffic recovery continues. It also has lowest exposure to air cargo, which reduces the headwind from the potential decline in air freight rates in 2023.

The bank added: “Our investor discussions suggest the market remains concerned about a potential rights issue given high leverage. However, we think these concerns are overdone given strong liquidity.”

Wizz is given a price target of 3,200p, with the bank noting that the eastern Europe-focused carrier is trading well below its historical average on five times 2024 earnings estimates.

Its recent performance has been impacted by an unfavourable hedge position as well as disruption costs as it ramped up capacity. However, Wizz has since restarted its hedging policy while competitors no longer benefit from the hedge prices secured in 2021.

The bank has an easyJet price target of 340p, believing that shares do not justify being above their historical average at 15 times forecast 2024 earnings.

It added: “Although we forecast fares and ancillary revenue per passenger to increase in 2023, easyJet's margins remain below pre-pandemic levels on our estimates.”