US Airlines:Post Q2Wrap;LK upgraded to Overweight,LUV downgraded to Neutral

We continue to believe that the majority of domestic revenue weakness is self-inflictedrather than secular, suggesting solutions ultimately rest in the hands of managements.But not all teams are likely to respond with equal vigor, in our view, a contributingfactor behind our downgrade of Southwest to Neutral (and removal from our AnalystFocus List). Meanwhile, though ALK shares have not witnessed the same sort ofrecessionary-rivaling declines that others have, we can no longer ignore what weconsider to be exemplary capital stewardship and labor cost control in recent years.While merger-related execution risk remains formidable, ALK shares at current levelsare simply too cheap to ignore, in our view, allowing our rating to rise to Overweight.

    Alaska upgraded to Overweight. An enviable track record of deleveraging. Theonly U.S. airline to achieve flat labor CASM over the past three years. Marginexpansion during one of the most aggressive hub raids we’ve witnessed. Granted, nounique merger experience that we can identify, and we’d still welcome DOJblockage though don’t anticipate it. Our upgrade assumes management’s priorsuccesses do count for something, and that integration goes more smoothly thansome fear. Based on our pro-forma 2017 EPS estimate of $7.85 versus $7.02consensus (may not be comparable) and resulting potential equity upside of ~20%,our rating is lifted from Neutral to Overweight.

    Southwest downgraded to Neutral. Like JetBlue under prior management,Southwest continues to resist certain industry efforts aimed at improving revenue(i.e. bag fees and plain vanilla fare increases). Southwest also faces larger laborhurdles than any other U.S. operator, though timing and outcome are far fromcertain. Our below-consensus outlook assumes $550m of incremental wage pressurein 2017 for all three unions, broadly in line what pilots alone are seeking, suggestingperhaps we are too generous. While shares were uniquely punished during earningsand are by no means grossly overpriced in our view, revenue lethargy and laboruncertainty suggests LUV shares may not participate as fully as others shouldindustry self-help initiatives take root. Our rating slips to Neutral.