Alaska Air Group Vs. Southwest Airlines: Which One To Buy?

| About: Alaska Air (ALK)

Summary

Low jet fuel prices help reduce expenses.

Both companies are growing, but which one is growing faster?

Alaska Air Group and Southwest have opposite investment strategies!

Are you looking for entry points in the airline industry?

Are you unsure which airline offers a more attractive investment opportunity?

Recently, I performed a DuPont ROE analysis on Southwest Airlines (NYSE: LUV) after the 10% drop in earnings. Someone asked what would be a better investment opportunity between Southwest Airlines or Alaska Air Group (NYSE: ALK). Since there are many comparison approaches, this article describes the growth of Alaska Air Group based on DuPont ROE analysis and the results are compared to those of Southwest Airlines.

Airlines' profits largely depend on jet fuel prices and employees' salaries. While salary expenses can be predictable to some extent, jet fuel prices are linked to crude oil prices. Over the past few years, jet fuel prices have declined due to plunging crude oil prices. However, crude oil began recovering lost ground in mid-January when the price rebounded from $33 per barrel to $50 per barrel. The World Bank expects crude oil to trade around $42.00 in 2016 followed by a recovery over the next ten years, Figure 1. Based on this, airlines' expenses should not increase significantly in the interim. However, we must keep an eye on changes in crude oil supply/demand.

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Figure 1

Alaska Air Group and Southwest Airlines released their earnings report on July 21st for the second quarter. While ALK's stock price rose 2%, LUV's stock price declined 10%. I felt that LUV's move could be exaggerated and maybe the market could be offering a great entry point. After a DuPont ROE analysis, it was evident that Southwest continued to grow on a year-over-year basis. Now it is the turn to analyze ALK and compare the results to LUV's. For this analysis, the assets and equity were taken at end of period as opposed to average. This simplification does not significantly impact the results of the analysis. Table 1 exhibits the quarterly data used to construct the DuPont ROE analysis.

Q2

Net Income

Pre-tax Income

Operating Income

Sales

Assets

Equity

2016

$ 260

$ 420

$ 418

$ 1,494

$ 7,035

$ 2,627

2015

$ 234

$ 376

$ 372

$ 1,437

$ 6,480

$ 2,219

2014

$ 165

$ 265

$ 263

$ 1,375

$ 6,314

$ 2,200

2013

$ 104

$ 169

$ 174

$ 1,256

$ 5,852

$ 1,543

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Table 1

Data from Table 1 suggests that the ROE has improved overall since Q2 2013 to Q2 2016. Profit margin continues to increase from 13.85% to 27.98% over the same period. Tax burden, interest burden and asset turnover remained unchanged. Interestingly, ALK decreased its financial leverage (assets financed by equity) from 2.92 in Q2 2015 to 2.68 Q2 2016, resulting in a slight decline in ROE. Had the financial leverage remained unchanged, ROE would have improved to 10.80%.

Alaska Air Group also rose the dividend which caused a decline in plowback ratio by 2%. Therefore, growth decreased from 9.37% in Q2 2015 to 8.61% in Q2 2016 (Table 3). Going forward, investors must keep an eye on the DuPont ROE ratio to determine if growth is decelerating.

Q2

Tax Burden

Interest Burden

Profit Margin

Asset Turnover

Financial Leverage

ROE

2016

0.62

1.00

27.98%

0.21

2.68

9.90%

2015

0.62

1.01

25.89%

0.22

2.92

10.55%

2014

0.62

1.01

19.13%

0.22

2.87

7.50%

2013

0.62

0.97

13.85%

0.21

3.79

6.74%

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Table 2

Q2

Dividend

EPS

Plowback Ratio

ROE

Growth

2016

$ 0.28

$ 2.11

87.0%

9.90%

8.61%

2015

$ 0.20

$ 1.80

88.9%

10.55%

9.37%

2014

$ 0.13

$ 1.20

89.6%

7.50%

6.72%

2013

$ -

$ 1.49

100.0%

6.74%

6.74%

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Table 3

Table 4 was extracted from LUV's DuPont ROE analysis. While ALK is increasing its dividend distribution resulting in a lower growth, LUV's plowback ratio is increasing causing a growth acceleration. It seems that LUV's management is more confident in finding profitable activities than ALK. Also, LUV's financial leverage has not changed in four years. Ideally, ALK should not decrease its financial leverage any further.

Q2

EPS

Dividend

Plowback

Growth

2016

$ 1.30

$ 0.100

92%

9.68%

2015

$ 0.91

$ 0.075

92%

7.79%

2014

$ 0.67

$ 0.060

91%

5.63%

2013

$ 0.31

$ 0.040

87%

2.88%

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Table 4

In brief…

Airlines should continue to enjoy low jet fuel prices in the interim which will keep their profit margins stable at least. From the DuPont ROE analysis, it seems that LUV is a better investment opportunity because the plowback ratio is increasing, giving more cash for the company to begin new projects. Alaska Air Group's financial leverage declined recently, causing its ROE to drop on a Y/Y basis. This event coupled with increasing dividend distributions hindered growth. Therefore, investors should consider a long position in LUV over ALK.

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

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.