FX-guidance Blog Business The most undervalued sector in the US and European stock market 04/20/2022

The most undervalued sector in the US and European stock market 04/20/2022

Time to take off the masks: from prohibition to recommendations

On Tuesday, April 19, the US Centers for Disease Control and Prevention (CDC) allowed citizens to visit 89 countries, entry into which was previously not recommended even for those vaccinated due to the difficult epidemiological situation. This is great news for cruise ship operators, air carriers and the entire transport-related entertainment industry. In addition, the mask regime was canceled on flights and, for the time being, partially for European air carriers, as in the case of BA and KLM.

Thus, Americans got the opportunity to visit the most popular countries for travel, including most European ones. In early March, European authorities lifted travel restrictions for those vaccinated against the backdrop of a high level of vaccination – on the continent, more than 75% of the population were fully vaccinated against coronavirus, 55% of residents got the third vaccination. For the unvaccinated, travel restrictions remain, but not as strict; for travel within the EU, in particular entry into France, a vaccination certificate is not required. The ban on entry into Europe remains for tourists from a small number of countries, mainly the Middle East, and China. Most travel restrictions in Europe will be lifted in late April/early May, before the start of the summer holiday season.

The US medical regulator has transferred 89 countries from the category “fourth level of the spread of coronavirus infection” (special conditions / very high risk) to the third (high risk), which does not imply strict bans, but only provides recommendations (be aware of). It is recommended that unvaccinated people complete the full course of vaccination and make their own health decisions based on the prescriptions of the medical regulator. The second level of distribution corresponds to medium risks, the first – low – in these conditions, recommendations that are not mandatory are valid. Some countries, in particular the Philippines and other resorts, are included in the “first and second level” category.

For travel within the United States, mandatory vaccinations and masks have been canceled. On Monday, April 18, the Federal District Court of Florida canceled the order on the mask regime in public transport systems, which the US administration and the medical regulator expected to extend until May 4. The mask regime on planes, buses, trains and on all types of domestic transport in the United States was in effect for about a year. Revision of the decision is possible through the court if the US CDC can prove that there is a new surge in diseases from another Covid-19 mutation.

In the United States, 66% of the population has already been fully vaccinated, and more than 30% have completed their third vaccination. Panic moods subsided in the country and the remaining bans are gradually being lifted. In the world, more than 60% of the population has already been fully vaccinated, 70% have received one vaccination, more than 5 billion vaccines are available for use, i.e. almost a dose for every inhabitant of the Earth.

What to buy?

We expect strong growth in the transport sector this summer, especially the most oversold cruise operators and air carriers, which have not yet recovered to pre-pandemic levels. There are few such sectors left.

Since the beginning of the year, the number of flights, incl. non-commercial is approaching 2019 levels, according to Flightradar24. This month, their number exceeded 189 thousand per day, compared with 182 thousand per day in April 2019 and from 64 thousand per day at the height of the pandemic in April 2020. The number of commercial flights operated per day in April is still at 19 % lower than pre-pandemic April 2019, but already three times more than at the height of the pandemic. Thus, after the restrictions are lifted, we are waiting for a full recovery of the aviation sector and the value of airline shares.

Over the past month, Delta’s flight sales and bookings have hit all-time highs, despite the carrier offering customers only 90% of its pre-pandemic seats, said Delta CEO Ed Bastian. Despite reporting a loss in the first quarter, Delta reiterated its earlier guidance that it would remain profitable in subsequent quarters of the year, weather the impact of rising fuel prices and a slow recovery in business travel amid the lifting of travel restrictions and rapid growth in online bookings.

Our quote targets, which we set more than a year ago for the oil and gas, financial and industrial sectors, are the levels of early 2020 (before the peak of the pandemic). The oil and gas sector surpassed this level by 33%, the banking sector, the first of the value sectors to reach the target, by 26%. At the same time, the shares of cruise operators are 60% below the level of early 2020, air carriers – 30%, aircraft manufacturers, in particular Boeing – 45%.

Our top 10 recommendations include International Air Group, Carnival, Rolls-Royce Holdings, EasyJet, United Airlines Holdings, Boeing, Embraer, Spirit Aerosystems, General Motors and Lufthansa.

Source: Bloomberg, ITI Capital

Normalized dynamics of key US sectors, %

Normalized dynamics of key US sectors, %

Source: Bloomberg, ITI Capital

Main risks of the global transport sector

Record rise in energy prices

The jump in fuel prices is the main threat to the profitability and profits of transport companies. Jet fuel prices have jumped 80% year-to-date to $390/gallon, the highest since August 2008. Gasoline prices are up 50% year-to-date, US gas prices are at their highest since 2006. Because of this, and other logistical factors, profitability has already fallen sharply and the cost of services of ground carriers (Uber, FedEx) has risen, cars, especially used ones, have risen in price, and the cost of air transportation is growing.

But we believe that the rise in fuel prices is a temporary factor that now plays a paramount role. The main rise in prices for hydrocarbons followed the start of a special operation in Ukraine, so it will not last long. Now the second, last, phase of the special operation has begun, and we believe that it will be completed by mid-May. If hostilities do not drag on, we rule out an embargo on Russian oil imports to Europe, which could otherwise push oil prices up to $200/bbl. and to the general collapse of the industry, since it is impossible to completely replace the supply of oil and gas from Russia to Europe for at least six months, follows from the comments of the Minister of Energy of Saudi Arabia.

Therefore, in the best scenario, we expect a correction in hydrocarbon prices after the completion of the special operation and during the discussion of the parameters of the peace agreement, which, against the backdrop of seasonal demand, will significantly contribute to the growth of shares of companies in the transport sector.

Source: Bloomberg, ITI Capital

Investors are too fixated on other risks

Recently, investors have been more concerned about geopolitical and other equally important factors, in particular, the active growth of rates in the United States and other countries of the world, the acceleration of inflation, the increased risk of a recession, and the slowdown in China’s GDP growth due to large-scale quarantine. On Monday, April 18, the head of the St. Louis Fed, James Bullard, who is more inclined to tighten the monetary policy than other US regulators, allowed the rate hike at the May meeting by 75 bp. and an increase in rates to 3.5%, to the upper limit of the forecast range by the end of 2022 (compared to the analysts’ forecast range of 2.2-2.5%), which means an increase in the benchmark by at least 50 b.p. at each of the remaining six US Central Bank meetings this year. At the same time, the news is more negative for the IT sector, media and communications companies, healthcare providers and other growth companies, whose overvaluations are highly dependent on the value of money in the future.

In general, the transport sector and air carriers are protected from the growth of rates, and as a rule they are distinguished by outstripping growth, but the general market volatility may have a negative impact on their quotes in the short term.

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