Is Allegiant King Of The Airline Stocks?

| About: Allegiant Travel (ALGT)

Allegiant Travel (NASDAQ:ALGT) operates a business completely different from that of any other airline. In fact, Allegiant would probably object to being referred to as an airline at all. Instead, it considers itself a complete travel company.

The company prides itself on serving small markets on routes where it does not face competition, and tries to maximize ancillary revenue, such as booking, seat selection and baggage fees. Allegiant earns extra income by selling hotel rooms and car rentals for travelers. This has resulted in industry-leading profit margins over the past several years, even compared to other low fare carriers like Southwest (NYSE:LUV), JetBlue (NASDAQ:JBLU) and Spirit (NASDAQ:SAVE).

The company relies heavily on older MD-80 series aircraft, which have been produced since 1979 (although the company is also adding a few Boeing 757s). This drastically lowers Allegiant's capital expenses, as other airlines are willing to sell used MD-80 aircraft for a pittance. Since high capital expenses significantly hinder most airlines' flexibility, this is a considerable advantage for Allegiant. On the other hand, the planes have a 25-35% higher fuel burn rate than equivalent modern aircraft. By contrast, Southwest has a modern fleet of Boeing 737s, JetBlue primarily operates a young fleet of A320s, and Spirit operates a very young fleet of A320 series aircraft.

As a result of its distinctive operating model, Allegiant tends to outperform peers when the economy is particularly weak. When fuel costs are low, Allegiant's biggest disadvantage vis-a-vis traditional airlines becomes much less significant. On the flip side, by undercutting other airlines' fares, Allegiant can keep its planes full even in a weak economy and thus continue to be profitable. On the other hand, the company suffers more than other airlines when fuel prices spike. But as noted in its presentations, Allegiant has been better able to survive high fuel prices in 2011 than in 2008.

On the other hand, Allegiant has been confronted with rising costs this year, including high fuel prices. For the first nine months of 2011, Allegiant managed to increase revenue by an impressive 17%. However, costs increased by more than 24% over that same period, leading to a year-over-year decrease in earnings per share from $2.67 to $2.01.

In its guidance for Q4, Allegiant noted more difficult comparable figures, and estimated an increase in PRASM (passenger revenue per available seat mile) of 11-13%. Because ancillary revenues grow at a much smaller rate, this likely translates to a 9-10% increase in TRASM (total revenue per available seat mile). However, the company projected a 7-9% increase in non-fuel CASM (cost per available seat mile). Additionally, the cost of fuel is likely to total $3.05-$3.10/gallon based on current market prices and the prices paid in October and November. This would represent an increase of more than 20% from the $2.51/gallon paid in Q4 2010. In total, this implies an increase in CASM (including fuel) of approximately 14%; i.e. faster than the pace of revenue growth.

Next year, the company should have an easier operating environment as fuel prices are not likely to rise much more from their current levels. Allegiant is also in the process of adding somewhat more fuel efficient Boeing 757 aircraft, which will also support potentially profitable service to Hawaii. Lastly, Allegiant is adding seats on each of its MD-80 series aircraft. By moving from 150 to 166 seats, the airline hopes to increase the revenue from each flight while spreading costs over more seats. The downside is that passengers will have less legroom, which may make some passengers more likely to choose other carriers.

If you are looking for exposure to the airline sector, and a company with a good track record of positive cash flow and a clean balance sheet, then Allegiant may be the stock for you. However, I am avoiding it for now, because it has a relatively high P/E ratio compared to other airlines, and because I am nervous about the age of Allegiant's fleet. Maintenance problems and a devastating crash took down CEO Maurice Gallagher's former company, ValuJet, which also relied on older aircraft.

While Allegiant has a very good safety and reliability record to date (in stark contrast to ValuJet), I am skeptical that they will be able to maintain this performance over the long haul with a fleet of 1980s era aircraft. If you do choose to invest in Allegiant, you should keep track of any safety or maintenance incidents to be sure that the company is continuing to generate reliable performance from its fleet.

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

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