3 Airline Buy Opportunities Fueled by Market Fears

Includes: ALGT, ALK, LUV
by: Vince Martin

The last month has been a difficult one for U.S. airline stocks, as higher oil prices, missed earnings, and economic fears have conspired to drive the sector down some 16%:

BUSAIRL 30 day chart
(Chart of Bloomberg United States Airline Index, courtesy Bloomberg.com)

There is some good news, at the moment, however -- thanks to the typical incompetence of the federal government, several FAA taxes expired last Friday. This is costing the federal government $30 million per day, most of which has been captured by the airlines through price hikes. Thehill.com reported last week that "there is no sign of the end." And while the $30MM figure is miniscule -- less than 1% of the industry's daily revenue -- it is nevertheless money that should go directly to the airline's bottom line. Regardless of the FAA impasse, there are still opportunities for value investors in the airline sector. While the major airlines are stereotyped (and rightly so) as being saddled with debt and hostage to oil prices, some airlines still offer profitable companies with reasonable balance sheets. Here are three:

1. Alaska Air Group (NYSE:ALK)

Alaska Air Group operates Alaskan Airlines and sister airline Horizon Air. The stock touched an all-time high of $70.61 earlier this month, before retreating about 13% during the recent sector slide. The company reported second quarter earnings last month, meeting analyst estimates of $2.44 per share before fuel and fleet accounting charges. GAAP earnings were $0.78 per share, off sharply from $1.60 in the year-prior quarter and $2.02 in the first quarter of 2011, due largely to higher fuel costs. Alaska Air, along with Spirit and Hawaiian, is one of the few companies that has passed along savings from the FAA expiration directly to its consumers; Spirit has already announced that its policy led to a jump in sales, and ALK may get a similar boost in its third quarter.

Despite the second-quarter struggles, the company has earned $7.88 on a trailing twelve-month basis, giving it a P/E around 8. Analysts surveyed by Reuters Finance anticipate 2011 earnings to be slightly lower (consensus around $7.50), with 2012 earnings at $8.49 per share. Levered cash flow for 2010 was an impressive $400MM, though a weak first quarter may lower that total for 2011.
ALK's balance sheet is solid as well. Through earnings and debt prepayment, the company has decreased its debt-to-capital ratio to 63% after 1Q 2011, a 12-year-low, well below the company's major competitors and a level easily sustainable through existing cash flows. The company's $1.15B in cash and securities is almost exactly equal to its long-term debt load, leaving only commitments for aircraft leases as its major net debt obligation. The company has kept revenues relatively stable in the last four years (3.3B, 3.4B, 3.1B, 3.5B) while growing earnings and reducing the company's debt load. If management can continue their performance, ALK looks undervalued at current levels.

2. Southwest Airlines (NYSE:LUV)

LUV is trading at an 18-month low, the victim of a steady, 8-month, 30% drop, which included the closing of the company's acquisition of AirTran. The company has earned 61 cents a share over the past twelve months, giving the company a reasonable, if unspectacular, P/E just below 17. Analysts expect a similar performance for 2011, before results from AirTran start to aid earnings in 2012, in which Southwest is anticipated to earn 99 cents per share.

Southwest's balance sheet is exceptionally strong; the company has over half of its market capitalization in cash, more than enough to pay off its long-term debt. The company has earned an impressive $1.5 billion in levered cash flow over the last twelve months, and recently paid out its 139th consecutive dividend (although the dividend is a miniscule .0045 per quarter, or 1.8 cents annually, giving a yield below 0.2%.) Southwest's long history of success gives credence to the idea that the recent lows are an attractive entry point, not a sign of things to come.

3. Allegiant Travel Company (NASDAQ:ALGT)

Allegiant Air provides low-cost, no-frills service from Las Vegas, Phoenix, Los Angeles, and Florida to smaller airports around the country. The company offers very cheap upfront fares, combined with fees (or ancillary revenue, as the industry prefers) for everything from seat choice to baggage to booking over the phone.

ALGT has had an impressive earnings history, earning 3.72, 3.76, and 3.32 in 2008, 2009, and 2010, respectively, defying the airline industry's downslide during the 2008-09 recession. Earnings are expected to dip to 2.79 this year before rebounding to 3.91 in 2012, giving the company a forward P/E of 11.

Allegiant's debt load is a manageable $145MM ($125 million coming from a recent short-term loan), easily covered by the company's cash balance. ALGT also offers a dividend yield of 1.75% (.75 annually). ALGT has slid some 14%, and earnings after the close on Monday may offer some good news to stem the slide.

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