In a research note this morning, JPMorgan analyst Jamie Baker downgraded United Continental (UAL) and Spirit Airlines (SAVE) to Neutral, cut Southwest Airlines’ (LUV) rating to Underweight, and upgraded JetBlue Airways (JBLU) to Overweight. While the analyst acknowledged that the industry remains on a path toward margin expansion for the first time since 2014, he argued that he cannot ignore the market’s recent de-rating of nearly two multiple turns.

MARGIN EXPANSION AHEAD AS MARKET DE-RATES: JPMorgan’s Baker told investors this morning that he continues to believe that a “trading trifecta” has formed for U.S. Airlines in investors’ favor. The analyst argued that the industry remains on a path toward margin expansion for the first time since 2014 amid lower year-over-year capacity, “robust” demand, “disciplinary” fuel, and no immediate risk to labor cost assumptions. Most stocks are “within 10% of their autumnal lows,” suggesting seasonal tradewinds may lift equities as they often do, he contended. Baker also pointed out that 2019 consolidated capacity is 50 bps higher than anticipated, but still roughly a point below 2018. The analyst has trimmed 2019 earnings estimates over 10% except for Spirit Airlines and introduced 2020 forecasts. For next year, he is above consensus for Delta, JetBlue, and Spirit. In 2020, he has above consensus forecasts for American, Delta, and Spirit. The analyst lowered his price target for American Airlines (AAL) to $46 from $53, Delta Air Lines (DAL) to $71 from $72, Southwest to $52 from $63, United to $95 from $98, while raising Spirit’s target to $59 from $51.

RATING CHANGES: After making changes to his estimates and price targets, JPMorgan’s Baker downgraded United Continental and Spirit Airlines to Neutral from Overweight, downgraded Southwest Airlines to Underweight from Neutral, and upgraded JetBlue Airways to Overweight from Neutral. Southwest and United entered the year as underperformers, but may be poised to potentially exit as winners, he acknowledged. Nonetheless, he would rather focus on the “names that have not worked than pound the table on the two that have.” For Southwest, Baker does not envision significant downside potential but rather views the stock as “stalled” at current valuation levels until such time a trajectory toward higher margins can better be established. Meanwhile, JetBlue is the “cheapest” of the domestic airlines and its target multiple is the lowest, the analyst contended. He sees over 20% upside potential in the shares. Additionally, Baker reiterated a Neutral rating for American Airlines. While he agrees that most of the debt is aircraft related and at very attractive all-in rates, the analyst believes American will be left with a material non-operating expense disadvantage if the economic cycle deteriorates significantly.