Like many airlines, Alaska Air (NYSE:ALK) just reported the best quarter in its history, thanks largely to low fuel prices. The company turns out margins and returns on capital that are consistently the best of the largest American carriers, while also owning the strongest balance sheet. To its credit, Alaska's management has consistently rewarded shareholders without leveraging, and while maintaining a long-term outlook on its business. Finally, Alaska's operational performance is the best of the major carriers, according to the Bureau of Transportation Statistics. At a P/E of 14.4 and a forward P/E of 12, Alaska is cheap both relative to the market as a whole and to other large non-legacy airlines.
Running A Strong Business
Alaska just reported its best quarter ever, with profit up 46% year over year. This was largely thanks to 34% reduction in fuel cost, pretty good for the industry, though not as good as American, which never hedges and recorded 38.5% fuel savings. These lower fuel costs allow Alaska and other airlines to add capacity and still make money with less revenue per flight. Alaska reported a 5.7% year-over-year decline in passenger revenue per average seat mile (PRASM), on 13% industry growth in the markets it serves. Despite the decline in unit revenue, pre-tax operating margin still increased 740 basis points, a testament to the impact of fuel. Alaska's fleet is also becoming about 2.5% more fuel efficient each year as older planes are retired. The company expects non-fuel costs to decline 0.5% this year, while other airlines like American are seeing a moderate growth in non-fuel cost, usually due to labor.
Of the new routes Alaska has launched in the past year, management says 70% are already profitable, and half would be profitable if jet fuel were $3 a gallon, approximately twice what is now. The company also reported double-digit growth in the number of passengers it shares with American Airlines (AAL). Earlier this year, the company managed to free up five planes by tinkering with their schedule, and has deployed those planes on new routes. The company has secured itself against Delta's (DAL) challenge to Seattle by investing in counter staff, more gates, and increasing flights to more than 1,000 per day. All of these are signs of strong management at Alaska.
Over the past year, Alaska has led most of the major carriers in margins and returns on capital. Alaska has the best margins across the board, though Spirit (SAVE) is a close second. Alaska's returns on invested capital have been far above the rest of the pack, and only Spirit has higher returns on assets. American has an astronomically high return on equity, but that has more to do with its lack of equity than anything else.
The Balance Sheet
Alaska has the strongest balance sheet of the major carriers, in large part, thanks to a concerted effort by management. As you can see below, the balance sheet in 2008 was very weak in debt/equity, debt/cash flow and interest coverage, but management has made steady progress over the past seven years. Now, Alaska has the lowest debt/equity of the major carriers at 0.3, and is the only airline with a debt/cash flow ratio below 1. It is the only airline with net interest income, according to management.
While plenty of investors would prefer a business that was more leveraged so it could return more cash to shareholders, I like this strategy for Alaska. Management has said it owns 80% of the fleet free and clear, which gives them less fixed cost in debt service if things turn south. It also shows a management team aware of the volatile nature of the industry, and focused on the long-term value of the business. As we'll see in the next section, management has still done an adequate job rewarding shareholders.
Below, we can use Stock Rover to see that Alaska's management has consistently rewarded shareholders. Over the past two years, Alaska has reduced its share count from 142 to 130 million shares, or just over 8%. At the same time, the company has doubled its dividend from the initial $0.10 a quarter to $0.20 a quarter in 2015. The company repurchased one-third of its stock since 2007.
Below, you can see that until a recent price spike, Alaska (in blue) had the highest dividend yield of the major airlines. That yield has never been high enough for a pure dividend yield investor, and airlines as a whole historically have not been very high yielders. While there is some prospect of dividend growth leading to decent yield on cost, I generally think of the dividend more as a "nice to have" rather than being primary to my investment thesis.
According to the Bureau of Transportation Statistics, Alaska has led major carriers in operational performance so far this year. Alaska's on-time rate of 86.6% shines compared to Delta's 84.2%, Southwest's (LUV) 78.25%, American's 76.5%, United's (UAL) 74.8%, JetBlue's (JBLU) 74.6%, and Spirit's awful 65.9%. Alaska has also done an exceptional job avoiding cancellations. Its cancellation rate of 0.5% is far better than its competition: In the first half of this year, American and JetBlue reported 2.5%, Spirit 2.29%, Southwest 1.74%, United 1.76%, and Delta 0.81%. This exceptional operational performance is a feather in management's cap.
I'm impressed by the results Alaska's management has put together: top-of-the-line margins, returns on capital, operational performance and balance sheet. Lower fuel prices are enabling the industry to increase capacity, lower unit revenue, and still make record profits, and Alaska is one of the airlines taking advantage of this opportunity to grow. While the legacy carriers are largely stagnant in their capacity growth, Alaska has the will and fiscal flexibility to expand its market share.
This article was written by
Disclosure: I am/we are long ALK, LUV, JBLU, VLRS. 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.