British Airways owner IAG preferred over easyJet by US investment bank

Morgan Stanley has issued 'overweight' ratings for British Airways owner IAG and Ryanair, highlighting their superior profitability and cash returns amid a projected divergence in aviation market performance. The investment bank anticipates an oversupply in European short-haul flights, leading to declining fares and negative unit revenues for carriers like easyJet (rated 'underweight'), while IAG is strategically positioned to capitalize on strong demand and reinforced pricing power on disciplined transatlantic routes. Ryanair is also favored for its robust free cash flow yield and potential for shareholder payouts, with IAG noted to be trading at a discount to US counterparts.

Analysis

Morgan Stanley has issued 'overweight' ratings for International Consolidated Airlines Group SA (IAG) and Ryanair Holdings PLC, citing superior profitability and cash returns amidst a projected divergence in aviation market performance. This bullish outlook contrasts with 'underweight' ratings for easyJet PLC and Lufthansa, which are deemed more exposed to near-term earnings risks. The US investment bank anticipates a significant oversupply in European short-haul flights, impacting low-cost carriers.

IAG, owner of British Airways, is strategically positioned to capitalize on firm demand and reinforced pricing power on transatlantic routes, where capacity is expected to fall by 2% this winter from the UK. BA, as the world's largest premium and corporate seat carrier, accounts for 70% of IAG’s transatlantic seats, benefiting from this supply discipline. Furthermore, IAG is noted to be trading at a steep discount compared to US carriers, suggesting potential valuation upside.

Conversely, the European short-haul market faces increasing pressure due to low-cost carriers like easyJet, Jet2, and Wizz Air expanding capacity faster than expected demand growth. This has already led to declining forward fares and negative short-haul unit revenues into the past summer. Ryanair, however, stands out within the short-haul segment, forecast to deliver a robust 6.6% free cash flow yield in FY25, ahead of peers, underpinning its 'overweight' rating and potential for further shareholder payouts.

Key Decisions for Investors

• Consider long positions in IAG and Ryanair, given Morgan Stanley's 'overweight' ratings, IAG's strategic positioning on disciplined transatlantic routes, and Ryanair's superior free cash flow yield.
• Exercise caution with European short-haul exposure, as the projected oversupply, declining forward fares, and negative unit revenues indicate significant near-term earnings risks for carriers like easyJet.
• Monitor transatlantic capacity discipline and short-haul pricing trends closely, as these will be critical indicators for future sector performance and potential shifts in market dynamics.