Time To Buy Alaska Airlines Before It Takes Off Again

| About: Alaska Air (ALK)
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Summary

ALK is a best of breed company.

Virgin Airlines merger should fly smoothly.

ALK still has long term growth potential.

ALK is cheap at these levels.

Best of Breed

Alaska Airlines (NYSE:ALK) is the best of breed Airline in the US in terms of how customers view it. In 2016, Alaska Airlines had an on-time performance track record of 86.05%, higher than all other legacy carriers and only lower than Hawaiian Airlines (NASDAQ:HA) among all domestic airlines. In January, the Wall Street Journal named Alaska Airlines the best airline in the US for the fourth year in a row. Alaska's best in breed status becomes even more evident when looking at its financials.

Airline

Op. M

Pr. M

RoA

RoE

ALK

24.50%

13.72%

11.01%

30.47%

JBLU

19.75%

11.44%

9.05%

21.02%

LUV

20.36%

10.99%

11.66%

28.41%

AAL

14.95%

6.66%

7.53%

56.81%

DAL

16.40%

11.03%

7.78%

37.80%

HA

21.41%

9.61%

12.62%

41.80%

UAL

13.61%

6.19%

7.68%

25.68%

Average

18.71%

9.95%

9.62%

34.57%

(Data Acquired via Yahoo Finance)

ALK boasts the highest margins in the industry, with only Hawaiian Air and Southwest (NYSE:LUV) coming close in matching its operating margin. Return on assets is also exceptionally high, and only slightly behind Southwest and Hawaiian.

Acquisition of Virgin

Last year, ALK completed its acquisition of Virgin Airlines, previously owned by eccentric billionaire Sir Richard Branson. In its annual shareholder presentation, it outlined its $240 million annual amount of savings from synergies coming from seven distinct categories.

Almost every company that has ever merged with another has promised huge amounts of synergies that would make the merger worthwhile. However, as any diligent observer will tell you, many promise synergies but fail to deliver. I do not believe ALK will be one of these companies.

Beyond the more apparent synergies that arise from economies of scale, logistics, online trafficking, etc. ALK can also benefit from being from a "cool" or "hip" factor by being associated with Virgin. While ALK often (albeit barely) bests Virgin in formal customer satisfaction ratings and reviews, Virgin's image of airline for the "cool modern leisure enthusiast" is stronger. This is due in large part to Virgin's name and to its founder who is infamous for his leisure activities.

Adopting Virgin's "cool" factor is one area where I believe ALK will have the most difficulty in merging the companies, and one that will take time. ALK will be phasing out the virgin brand entirely by 2019. While running the company under a single brand should be most beneficial in the long term, in the short term, it remains uncertain how any Virgin Airlines loyalists would feel about the change.

In their last earnings conference call (Q4 2016), CEO Bradley Tilden mentioned that 15% of Virgin revenue was being booked from Alaskaair.com. This translates that ALK customers have little to no issue with flying on a Virgin flight. However, ALK failed to provide any numbers of customers booking Alaska Airlines through Virgin portals.

Overall, I do not expect much reluctance or resentment by loyal virgin customers toward Alaska Airlines for replacing the brand. Both cater to "leisure enthusiasts" and regular fliers, who loath the legacy carriers like Delta (NYSE:DAL), United Airlines (NYSE:UAL), etc. While they are still working on the process of merging the two companies' cultures and will phase out the brand virgin in favor of ALK, the two companies had already very similar in culture and service, which leads me to believe the process should go relatively smoothly.

Long-Term Growth Outlook is Good

On top of growth through the acquisition of Virgin, Alaska Airlines is also expanding organically. Excluding revenue from Virgin, ALK saw 4% revenue growth for the year of 2016. With the acquisition of Virgin, ALK now has significant market share in both LA and San Francisco. However, there still lies significant growth opportunities there and elsewhere in the US. After the acquisition, ALK became the fifth largest airline in the US, but is still dwarfed by the larger legacy carriers. In the past 15 years, management has gradually and meticulously expanded ALK into new markets.

With higher margins, better service, and an overall better brand image than the rest of the industry, this gives the company a strategic advantage over other airlines which can be further used to gradually continue to expand over the coming decade. The company's management has done an excellent job at this in the past realizing the most profitable destination to expand to, and there is little reason to believe it won't continue to excel at this over the next decade.

Valuation

Trading at just 10.5 times forward earnings, ALK looks cheap compared to the rest of the S&P, but for good reason. Until around five years ago, the entire industry was infamous for bankruptcy and price wars. Investors required a higher rate of return for fear of returning to the bankruptcy prone environment that was the hallmark of the industry from the period from 2000 to 2010. However, ALK has prided itself on maintaining a stellar balance sheet and being one of the few major airlines to have never gone through bankruptcy.

Airline

MC (BIL)

TPE

FPE

Debt/Equity

ALK

11.26

13.95

10.55

0.62

JBLU

7

9.35

10.45

0.78

LUV

33.26

15.24

11.73

0.45

AAL

21.13

8.72

7.66

2.25

HA

2.48

10.62

9.25

0.81

UAL

22.08

10.24

8.57

1.43

(Data Acquired via Yahoo Finance)

Despite having recently taken on debt from Virgin, ALK still has one of the lowest debt-to-equity ratios in the industry, with only southwest being lower. Before the acquisition, the ratio was even lower, around 40%. Management announced in its last conference call that it intends to again bring it down to that level.

While ALK is trading at a higher earnings multiple than most of its competitors, I believe it is more than justified given its superb margins, balance sheet, and the overall quality of the company. Coming off a 10% decline since the beginning of March, now seems an appropriate time to buy the stock before it takes off again.

Disclosure: I am/we are long ALK.

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.