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Analyst Blog: Earnings Preview - ESP

Airline stocks seem to be back in favor once again. The stocks, which had been struggling for the most of 2016, ended the year on a triumphant note. This can be made out from the fact that the NYSE ARCA Airline Index has gained almost 19% in the last three months.

Moreover, the Zacks categorized Transportation-Airline division gained 19.43% in the final quarter of 2016, comfortably outperforming the S&P 500 Index that grew just 1.81% during the period.

The improvement in the Zacks industry rank of the Transportation-Airline division to 27 (out of more than 260 groups) from the 200+ rank carried a few months ago also bears testimony to the turnaround in fortunes for this key sector (one of the 16 Zacks sectors).

Factors at Play

One of the key factors to have plagued airlines for most of 2016 was declining PRASM (passenger revenue per available seat mile: a measure of sales relative to capacity for a carrier). However, unit revenue woes seem to be mitigating, courtesy of bullish forecasts pertaining to this key metric for the final quarter of 2016.

For instance, Delta Air Lines’ (DAL - Free Report) passenger unit revenue was flat year over year for December. The metric is expected to decline 2.5–3% in the fourth quarter, which is a much more favorable reading than the earlier projection of a decline of 3% to 5%.

American Airlines Group (AAL) now expects total revenue per available seat mile (TRASM) for the fourth quarter in the band of decline of 1% to an increase of 1%. The view represents a marked improvement from the earlier guidance, when the metric was expected to decline in the band of 0.5–2.5%.

JetBlue Airways (JBLU - Free Report) expects RASM to decline in the band of 1% to 2% in the fourth quarter. The forecast is favorable when compared with the 3.5% RASM decline witnessed in the third quarter.

Apart from bullish unit revenue-related updates, developments like the completion of the acquisition of Virgin America by Alaska Air Group (ALK - Free Report) and the resumption of commercial scheduled flights to Havana – a favorite tourist destination – after more than five decades have resulted in the sector participants flying high.

The fact that things are looking up for airline stocks is further highlighted by the fact that Warren Buffett – one of the most revered investors of all times – put his bets on four airline heavyweights, namely Delta Air Lines, American Airlines Group, Southwest Airlines Co. (LUV) and United Continental Holdings Inc. (UAL). The move is all the more significant as Buffett had historically been against investing in this sector. In fact, his last investment in airlines was in the 1980s.

Given the favorable backdrop, it is very much likely that airline stocks will report impressive results in the fourth-quarter 2016 earnings season. Moreover, an earnings beat might not be too difficult for carriers in the quarter due to reduced expectations.

Naturally, it is a prudent idea to add such stocks to one’s portfolio for handsome returns.

How to Make the Right Choice?

With quite a few companies in the airline space, the task of selecting the right stocks is by no means an easy one. The process is akin to searching for ‘a needle in a haystack’ unless one is aware of an appropriate method to make the right choice.

One way to narrow down the list of choices is by looking at stocks with a favorable Zacks Rank of #1 (Strong Buy), 2 (Buy) or 3 (Hold) alongside a positive Earnings ESP.

Earnings ESP is our proprietary methodology to determine which stocks have the best chance to surprise in their next earnings announcement. It shows the percentage difference between the Most Accurate estimate and the Zacks Consensus Estimate. Our research shows that for stocks with this combination, the chance of a positive earnings surprise is as high as 70%. An earnings beat boosts investor confidence in the stock, which is reflected in its rapid price appreciation. You can uncover the best stocks to buy or sell before they’re reported with our Earnings ESP Filter.

5 Attractive Picks

With the aid of the above methodology, we have zeroed in on five airline stocks that are likely to report better-than-expected earnings per share in the fourth quarter. We believe that these stocks could turn out to be great additions to your portfolio and are worth a look.

Hawaiian Holdings, Inc. (HA - Free Report) , which engages in the scheduled air transportation of passengers and cargo, is our first choice in the list of likely outperformers. The company is expected to release fourth-quarter results on Jan 24. We expect this Honolulu, HI-based carrier to surpass expectations as it has an Earnings ESP of +5.47% and a Zacks Rank #1. You can see the complete list of today’s Zacks #1 Rank stocks here.  The Zacks Consensus Estimate for fourth quarter has risen 15.3% over the last three months to $1.28 per share.

Our next choice is Delta Air Lines (DAL - Free Report) , which will kick-start the fourth-quarter earnings season for airlines on Jan 12. The Atlanta, GA-based carrier is expected to outperform with respect to the bottom line as it has an Earnings ESP of +1.24% and a Zacks Rank #3. In fact, the carrier has an impressive track record with respect to earnings, having outpaced the Zacks Consensus Estimate in three of the last four quarters.

Las Vegas, NV-based Allegiant Travel Company (ALGT - Free Report) also features in our current list of favorites owing its Zacks Rank #3 and an Earnings ESP of +0.86%. The Zacks Consensus Estimate for the fourth quarter rose by 2 cents to $2.32 per share over the last month.

The parent company of Allegiant Airlines, which focuses on linking travelers in small cities to world-class leisure destinations, is expected to reveal its fourth-quarter results on Jan 31.

Based in Long Island City, NY, JetBlue Airways (JBLU - Free Report) is a low-cost passenger airline that operates primarily on point-to-point routes. The carrier has a Zacks Rank #3 and an Earnings ESP of +4.26%. The Zacks Consensus Estimate for the fourth quarter has increased by 3 cents over the last month to 47 cents per share. The carrier is expected to unveil its quarterly results on Jan 26.

Our final choice is Seattle, WA-based Alaska Air Group (ALK - Free Report) . The company carries a Zacks Rank #3 and has an Earnings ESP of +6.2%. The Zacks Consensus Estimate for the fourth quarter has increased by 4 cents over the last month to $1.29 per share. The carrier is expected to unveil its results on Jan 19.

Zacks' Top 10 Stocks for 2017

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