After an up-and-down 2024 for the U.S. airlines industry, our Freight Transportation & Airlines Analyst Ravi Shanker explains why he is bullish about the sector’s trajectory over the next year.

----- Transcript -----

Welcome to Thoughts on the Market. I’m Ravi Shanker, Morgan Stanley’s Freight Transportation and Airlines analyst. Today I’ll discuss why we remain bullish on the US Airlines industry for 2025.

It’s Friday, December 13, at 10am in New York.

The Airline industry entered 2024 with good momentum, lost it during the middle of the year with some concerns around the economy and capacity, but then turned it around in the fall to finish the year with the strongest run that the Airlines have had since the pandemic. The coast looks clear for 2025, and we remain bullish on the US Airlines for next year.

While many airline stocks enter 2025 close to post-pandemic if not all-time highs, valuations are still attractive enough across the space to see upside across the industry. The big question right now is: will the focus on premium services continue to pay off, or will there be a resurgence in domestic travel that alters the market dynamics? We think the answer is both.

Premium beneficiaries will continue to shine in 2025. We believe the premiumization trend in the industry is structural and will continue next year. Legacy carriers have successfully capitalized on this trend, enhancing their revenue streams significantly through upgraded service offerings such as premium seating and lounge access. This move isn't just about luxury—it's a calculated play to boost ancillary revenues, which are becoming a more critical component of financial stability in the airline industry. The premium leaders are building annuity-like business models – think razorblades, printers or smartphones – where the sale of a popular gateway product is followed by the bulk of the profitability coming from ancillary revenues generated in the following years, as loyalty and adjacent revenues contribute a steady stream of earnings and free cash flow to the airlines.

On the flip side, the conversation around better margins on domestic travel is gaining momentum as well. 2024 saw a big shift where several domestic carriers made significant changes and even in some cases fundamentally overhauled their business models to fly less, fly differently, bundle fares, and move upmarket. This change brought significant disruption in 2024 but could be set to pay dividends in 2025 and reignite investor interest in these domestic names. This shift toward domestic travel could potentially redistribute market share and redefine competitive dynamics within the entire Airlines industry.

To sum up, the setup for 2025 looks very good. But volatility could remain high due to external factors. The biggest risk into 2025 -- especially the second half of [20]25 -- continues to be the macro backdrop. More specifically, our economists' view of a sharply slowing GDP growth and services spending environment in the second half of [20]25 and into [20]26. While we take comfort from the resilience of travel spending so far, we know that things could change quickly. We will continue to keep you updated throughout the next year.

Thanks for listening. If you enjoy the show, please leave us a review on Apple Podcasts and share Thoughts on the Market with a friend or colleague today.