Ravi Shanker: A Bullish Outlook for Airlines

Over the past few years, the airline industry has faced fluctuations between too hot and too cold across demand, capacity and costs. Could conditions in 2023 be just right for increased profitability?

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Welcome to Thoughts on the Market. I'm Ravi Shankar, Morgan Stanley's Freight Transportation and Airlines Analyst. Along with my colleagues, bringing you a variety of perspectives, today I'll discuss our 2023 outlook for the airline space and some key takeaways for investors.

As 2022 draws to a close, the outlook for airlines going into next year continues to be bullish. We think that 2023 is going to be what we call a "Goldilocks" year for the airlines, simply because we go from three years of conditions being either too cold during the pandemic, or too hot last year, to conditions being just right. This should be enough for the airlines to remain stable and to top 2019 levels in terms of profitability. However, the biggest question in the space is about the macro backdrop and consumer resilience.

Everything we are seeing so far suggests that there are no real cracks in terms of the demand environment. We expect a slight cool down on the leisure side, but some uptick on the corporate and international side going into next year.

As for pricing, when the irresistible force of demand met the immovable object of capacity restrictions in 2022, the net result was a significant increase in price, which was up 20 to 25% above pre-pandemic levels. This is arguably the biggest debate between the bulls and the bears in the space, regarding where the industry eventually ends up. We believe the pricing environment will cool slightly sequentially as capacity incrementally returns, but will stabilize well above 2019 levels. In addition, the return of corporate and international travel will be a mixed tailwind to yield in 2023.

Costs have been another big debate for the space over the last 18 to 24 months. New pilot contracts are one of the things that we are closely tracking. And we do think that inflation should start to moderate in the back half of the year as we lap some really difficult comps in the cost side, but also as airlines get a little more capacity in the sky with the delivery of new, larger gauge planes and the return of some pilots. There might be some risk for the space in 2024 and beyond, but for 23 we still think that capacity is going to be relatively constrained in the first half of the year, and only start to really ease up in the second half of the year.

And lastly, jet fuel has been very volatile for much of 2022. Given this, we model jet fuel flat versus current levels, but continue to expect volatility in price and note that current levels already imply a year over year tailwind for most of 2023.

So all in all, we do expect that 2023 earnings will be above 2019 levels. And we point out that the market has not yet priced this into the airline stocks, which are currently trading at roughly year end 2020 levels.

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