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I have long been a proponent of the legacy carriers as an under-appreciated investment opportunity. Market leaders United (UAL) and Delta (DAL) are both trading for less than five times analysts' estimates for 2012 earnings. Barring a substantial fuel price spike or serious slowdown in demand, these companies will provide an above market return on investment.

However, investing in large airlines does come with risks. The overall market is not growing much, and so these airlines are forced to seek profit increases through cost cutting, route optimization, and a strong price environment. The large legacy carriers face difficult tradeoffs between trying to grow market share and trying to increase margins. For this reason, many commentators are frequently worried that high cost legacy carriers will go back to the destructive price competition of last decade.

It thus may be wise for investors to look at small-cap airlines that compete in profitable niches. These airlines provide a somewhat differentiated product, giving them an inherent advantage over large hub-and-spoke carriers. Furthermore, since these companies are not beginning from the massive networks of the legacy carriers, they typically have profitable expansion opportunities. This prospect for organic growth is very valuable in an industry that cannot otherwise afford expansion with jet fuel prices significantly above $3/gallon. Without further ado, here are three small but growing airlines worth further consideration.

1) Hawaiian Holdings (HA): Hawaiian Holdings is the parent company of Hawaiian Airlines, and is one of my favorite stocks right now. Hawaiian trades for less than five times 2012 analyst estimates of $1.15 in EPS. The company grew capacity by nearly 13% in Q1, and is adding four new A330 aircraft in 1H12 (one of which has already arrived). These aircraft will support continued expansion of profitable long-haul routes. The company began service to Fukuoka (its 3rd Japanese destination) last week, and begins services to New York in early June. An additional strength of Hawaiian is its international exposure in Japan and Australia, both of which have strong currencies relative to the US dollar. This makes travel to Hawaii more appealing for potential customers from those countries. Hawaiian also benefits from holding a near monopoly on air travel within Hawaii. This guarantees pricing power on those routes and gives Hawaiian a competitive advantage over other carriers to Hawaii, insofar as the company can offer its long-haul customers free connections within Hawaii.

2) Allegiant Travel Company (ALGT): Allegiant Travel Company is the parent of Allegiant Airlines, which is a low-cost carrier providing low frequency service primarily aimed at vacation travelers from small markets. Allegiant trades slightly above 15X analyst estimates for 2012. The company has a strong track record of growth and has been very focused on deploying its aircraft in the most efficient manner possible (e.g. dropping underperforming routes). Allegiant has posted 36 consecutive profitable quarters, and has shown the ability to quickly adapt to changing industry trends (such as high fuel prices) while maintaining industry leading margins. Allegiant is also looking to Hawaii for growth, and recently announced service to Honolulu from Las Vegas and Fresno, which begins in late June. The company also recently began charging for large carry-on bags. This additional fee revenue may help pad Allegiant's margins. Continued earnings growth could make Allegiant's a bargain even at 15X, but I think it has less upside than Hawaiian from its Friday close at $59.15.

3) Spirit Airlines (SAVE): Spirit Airlines is an ultra-low cost carrier that has been on an expansion tear in recent years. The company is expected to post nearly 30% revenue growth this year. Spirit trades at less than 12X analysts' 2012 estimates of $1.95 in EPS. With a young and growing fleet of Airbus aircraft, Spirit leads the industry in fuel efficiency, thus mitigating the risk of high oil prices. The company has undertaken a massive expansion at Dallas Fort Worth International Airport over the past year, and is continuing to grow there (taking advantage of American's bankruptcy woes). Spirit may face slight pressure due to new government regulations that force it to disclose more fees upfront. For instance, it's new introductory fares from Dallas are now advertised at $28.79, rather than $9. However, Spirit is undoubtedly the airline price leader, and will continue to attract a large following of price-conscious customers. While Spirit was grounded by a pilots' strike in 2010, the company and the pilots' union agreed to substantial wage raises and signed a 5-year contract. The company is unlikely to face a similar situation in the near future.

All of these airlines are small enough to be nimble in response to changing economic conditions, in a way that the larger carriers cannot be. My top pick is Hawaiian, simply for valuation reasons.

Source: 3 Small Cap Airlines Poised For Profits