Allegiant Travel (NASDAQ:ALGT), once a cheap growth stock, has seemingly run out of gas. Currently priced at $171 per share the stock has been moving south since hitting a high of 232.87 on August 14, 2015. The valuation is too rich, EPS has come down and gross margins have declined.
Alleigants Business Model
Allegiant is a low cost airline headquartered in Las Vegas. Their business plan is based around flying leisure travelers from smaller cities to leisure destinations such as Florida, and Las Vegas. Once a fast rising growth stock the companies EPS has begun to go down as margins continue to contract. The company has run out of destinations to travel to and growth is coming to a halt. I believe this presents a clear short oppurtunity on the basis of decling growth and valuation contraction.
Allegiant has gotten expensive compared with its peers. Allegiant has a P/E ratio of 13.05. Compared with the industry average of 8. Investors are paying a premium for a company with declining EPS and gross margins. Their P/E is much higher then industry stalwarts like American at 8.71, and United at 7.96. It is also higher then comparable low cost carriers like JetBlue at 8.5, and Alaska Airlines at 9.4. If Allegiant's growth was significantly stronger then I believe paying the premium would be worth it, but I believe we are in the midst of a valuation contraction.
Why Allegiant is Going Lower
Which brings me to my next point that growth at Allegiant Travel is starting to slow down. They are reliant upon ancillary revenue such as that from hotels and rental cars due to their rock bottom airfares. The current outlook for hotels is very soft with occupancy and growth rates both dropping sharply. The rental car business has also fallen off of a cliff due to the popularity of ride sharing. The decline year over year in ancillary revenue is going to cause them to have to make a fundamental change to how their business operates. They are not going to be able to generate enough revenue to remain profitable if the current trends hold.
After posting average EPS of 39% over the past 5 years Allegiant is only expected to post growth of 2.87% over the next 5 years, which is exactly the type of growth slowdown which can cause a valuation contraction as investors are no longer willing to pay a premium for a company with declining growth.
I believe the company's margins will come under pressure as it no longer will continue to benefit from rock bottom fuel prices. Allegiant also still faces issues with labor, with their COO saying, "they continue to struggle with crew availability." With both the hotel and rental car markets softening, and margins coming under pressure Allegiant is going to need to find a way to generate more revenue. Allegiant also faces tremendous risk should any economic downturn arise, since its business model focuses primarily on leisure travels headed on vacations.
Allegiant was once a great airline growth pick but it has gotten to expense and the valuation is not supported by the slowing earnings growth. Allegiant is looking at spending more and making less which is not a recipe for growth. Look for the stock price to contract as their gross margins get tighter. I have Allegiant rated as a sell based upon shrinking margins and a valuation contraction.
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.
Additional disclosure: Interviewed with company on Feb 17th.