Morgan Stanley starts EU airlines coverage. This is the top pick

Investing.com -- Morgan Stanley has initiated coverage on Europe’s airline sector with a broadly cautious stance on short-haul carriers but sees stronger earnings potential from long-haul operators.

The bank’s analysts describe the setup as “Short Haul Pain, Long Haul Gain”, flagging that transatlantic routes remain the most profitable part of the market while U.K. leisure capacity expansion risks putting pressure on low-cost players.

They note that capacity growth into winter is heavily skewed towards low-cost carriers, with U.K. outbound leisure markets now running at up to four times pre-pandemic levels.

Forward fares and trading updates already point to declining yields into next summer, suggesting sustained pricing pressure for easyJet, Jet2, and Wizz Air.

On the flip side, long-haul operators with exposure to premium transatlantic travel are expected to maintain pricing power thanks to capacity discipline and resilient corporate demand.

“The U.K. remains the market’s linchpin,” a team led by Axel Stasse writes, highlighting that London accounts for a third of all transatlantic seats and is set to see capacity fall by 2% year-on-year.

International Airlines Group is named the top pick, with coverage initiated at Overweight. The analysts argue that British Airways’ dominant slot position at Heathrow and strong premium cabin mix leave the group best positioned to benefit from disciplined supply and high-margin U.S. routes.

They expect consensus profit forecasts to move higher, citing conservative market assumptions on unit costs and fuel.

The analysts see free cash flow strengthening into 2026–27, creating scope for shareholder returns to exceed current guidance. They also stress that IAG and Ryanair lead the sector in profit per Available Seat Kilometres (ASK) and cash returns, and project multi-year buybacks for both groups.

Ryanair is also rated Overweight on expectations that its cost base will allow it to sustain growth and recover pricing after last year’s decline.

Morgan Stanley sees potential for additional buybacks given strong cash generation.

Among the rest of the sector, Air France-KLM and Jet2 are rated Equal-weight, while easyJet and Lufthansa are initiated at Underweight due to earnings risk and limited rerating catalysts.

Wizz Air is also initiated at Equal-weight, with the bank expecting fiscal 2026 (FY26) net income guidance to be revised lower due to pressure from capacity growth and higher financial costs.

Analysts argue that valuation dispersion is likely to grow as supply-demand conditions diverge between long-haul and short-haul markets. IAG still trades at a discount to U.S. peers, the analysts note, but commands one of the strongest cash return profiles in the sector.

The team forecasts FY25 EBIT upgrades for IAG even under conservative assumptions, while the investment case for other flag carriers hinges on macro recovery in continental Europe and potential upside from future airspace reopening.