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Many investors swear-off airline stocks because the industry is very competitive. In a nutshell, airlines compete on price and find differentiation difficult. As such, travel by plane is a commodity and airline firms do not have an economic moat. Warren Buffett and others warn that an economic moat is necessary for a firm to maintain pricing when other companies attempt to steal customers by slashing prices.

However, most investors who ignore airlines are inconsistent because the same investors typically invest in other commodity producers. They invest in oil or mineral stocks which produce fungible commodities. Even banks provide commodity goods since the money one bank lends is indistinguishable from money another bank lends. Lenders compete primarily on interest rate (the price of borrowed money). Hype aside, Mr. Buffett and other proponents of economic moats invest in lenders and commodity producers.

Since investors tend to ignore the need for sustainable competitive advantage in other industries, why should we hold airlines to a higher standard? Instead, regional airlines should be given a fair look for bargains:

Ticker

Company

P/E (ttm)

P/S

P/B

P/FCF

Div Yield

Insider Transactions

RJET

Republic Airways

N/A

0.05

0.24

0.96

4.07%

SKYW

SkyWest Inc.

12.67

0.19

0.45

3.57

1.34%

-0.03%

PNCL

Pinnacle Airlines

N/A

0.05

0.55

0.82

4.68%

JBLU

JetBlue Airways

12.53

0.29

0.70

6.04

1.03%

HA

Hawaiian Holdings

3.86

0.13

0.79

N/A

13.78%

LUV

Southwest Airlines

12.21

0.48

0.9

4.73

0.22%

44.44%

GOL

GOL Linhas A

14.16

0.45

1.06

7.57

1.64%

ALK

Alaska Air Group

6.85

0.47

1.61

3.32

-18.30%

RYAAY

Ryanair Holdings plc

12.67

1.34

1.8

17.93

CPA

Copa Holdings SA

9.91

1.82

2.53

N/A

2.42%

ALGT

Allegiant Travel Co.

15.94

1.2

2.62

13.76

1.66%

-1.55%

LFL

LAN Airlines S.A.

22.06

2.11

6.92

N/A

0.72%

It appears that RJET, SKYW, PNCL, JBLU, HA, and LUV are selling at a price to book discount. Using financial data from June 30, 2011, we can use the Altman Z-Score* to help distinguish value investments from value traps:

Ticker

Company

P/E (ttm)

P/S

P/B

P/FCF

Altman Z-Score

RJET

Republic Airways

N/A

0.05

0.24

0.96

0.86

SKYW

SkyWest Inc.

12.67

0.19

0.45

3.57

1.57

PNCL

Pinnacle Airlines

N/A

0.05

0.55

0.82

0.84

JBLU

JetBlue Airways

12.53

0.29

0.7

6.04

0.99

HA

Hawaiian Holdings

3.86

0.13

0.79

N/A

1.15

LUV

Southwest Airlines

12.21

0.48

0.90

4.73

4.34

Southwest Airlines (LUV) is the only firm on the list that sells at a discount to book value and has an Altman Z-Score in the “safe zone.” It is worth consideration as a potential value investment.

To be fair, Southwest is also one of the more differentiated and well-managed airline firms. It engages in responsible fuel hedging, on-boards and off-boards quickly, and has a fun work-culture. It is different from other airline experiences. For an airline, it may have a relatively wide economic moat.

*One predictive measure of bankruptcy is the Altman Z-Score. This score places companies into three groups: “safe” (Z-score > 2.99), “grey” (Z-score between 2.99 and 1.81), and “distressed*” (Z-score < 1.81), and is surprisingly useful for identifying bankruptcy risk in the coming year. This method of segmenting companies uses of fundamental (financial statement) data and market capitalization only.** Beyond credit risk prediction, companies with higher Z-scores have been shown to outperform companies with lower Z-scores, in aggregate. One sector has not been accurately modeled: Altman’s Z-score has not accurately predicted the bankruptcy risk of financial companies.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Source: Finding Value Among Regional Airlines