Airlines 3Q19 earnings preview: slower capacity and improving pricing trends

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BOfAML | We modestly update our forecasts reflecting fuel prices and monthly traffic data reports. European airlines in our coverage have reported 6.5% ASK growth on average in 3Q19 and we look for 3.8% in 4Q19. We expect RASK recovery with flat unit revenues in 3Q19 on average and 1.7% yoy improvement in 4Q19.

As we head into 3Q19 earnings, we modestly update our forecasts reflecting fuel prices and monthly traffic data reports. We have also updated our forecasts for easyJet following its full year trading statement release earlier this week. We raise our 2019E EBIT by c1% on average, putting us slightly ahead of consensus.

Our analysis of seat capacity schedules until February 2020 suggests that supply discipline is returning in Europe. Domestic Europe capacity growth slowed to 3% in 3Q19 from 5 % in 1H19. This is expected to persist in 4Q19 with only 2% growth in winter 2019/20. European airlines in our coverage have reported 6.5% ASK growth on average in 3Q19 and we look for 3.8% in 4Q19.

Pricing improvement in 3Q19

We expect RASK recovery with flat unit revenues in 3Q19 on average and 1.7% yoy improvement in 4Q19. September has seen a number of airline bankruptcies in Europe with Thomas Cook being the largest. The grounding of the B737- MAX since March 2019 and delays in the planned deliveries have resulted in lower supply and are overall favourable for pricing in the airline industry. We estimate that the MAX represents ~1.1% of the European capacity at the time of grounding. As a result, we see improvement in unit revenue in winter 2019/20.

We have already heard some early thoughts on 2020 plans (IAG, Ryanair, easyJet) and we expect to get initial outlooks for 2020 capacity plans from Air France-KLM, Lufthansa, and Wizz Air. IAG, Ryanair and easyJet are guiding to slower growth in 2020. Uncertainty over Brexit and the B737 MAX timeline will influence management’s communication. We expect Air France-KLM management to present a positive message at its 5 November Capital Markets Day and quantify the impact of its new measures on unit revenue and costs (our FY20E EBIT is 6% above consensus). We expect IAG management to give a reassuring message at the Capital Markets Day on 8 November.

Valuation at historical lows – Europe at discount to global

European yield growth has been weakening since summer 2018. Our analysis of passenger vs. GDP growth since 1980 shows a 1.4x multiplier for global and 2.5x for Europe. Although a worsening macro outlook is a headwind, we think this is reflected in shares with valuations at historical lows. Over the past year, European airline multiples have contracted with P/Es c15% lower on average. Legacy carriers have de-rated more than LCCs (low-cost carriers). On our estimates, European airlines are trading at 7.5x 2020E P/E, which represents a discount to global airlines.