Using Ratios To Identify Stocks Set To Outperform Their Peers: Airlines Rankings

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Includes: AAL, ALK, DAL, LUV, UAL
by: Stock Scrutiny
Summary

I'm introducing the airline industry to my research project.

Included are the stocks' rankings in debt, profitability, efficiency, and growth categories.

YTD performance is shown in comparison to each company's score.

Intro

This is the first of my analyses in 2019, and I decided to start things off by adding a new group of stocks to the project: the major airlines. Adding more industries to my research is one of my main goals of the year, as it will not only give me more data but will also decrease any major variation seen in the results. Any new readers that wish to see a detailed explanation on how I arrive at these results, please see my introductory article that elaborates on my process. As a quick summary, I believe that over the long run, stocks that rank higher than their competitors financially (according to my assortment of ratios) will outperform stocks that have a lower ranking in that same industry. Ratios have their shortcomings, but if utilized properly, they can be helpful in analyzing a company's current financial position.

Included in this analysis is Delta Air Lines (DAL), Southwest Airlines (LUV), American Airlines (AAL), United Continental Holdings (UAL), and Alaska Air (ALK), and pricing data is gathered from Nasdaq, while scores were calculated using financial statements from E-Trade.

Ratio Research

Debt

DAL

LUV

AAL

UAL

ALK

Current Ratio

.35 (5)

.64 (1)

.48 (4)

.55 (3)

.61 (2)

Quick Ratio

.28 (5)

.58 (1)

.39 (4)

.47 (2)

.42 (3)

Defense Interval

18.16 (5)

84.65 (1)

48.25 (3)

47.8 (4)

68.45 (2)

Interest Coverage Ratio

15.36 (2)

34.85 (1)

3.19 (5)

5.73 (4)

10 (3)

Current Liquidity Ratio

899 (4)

314.5 (1)

1027 (5)

546 (3)

392 (2)

Debt/Equity Ratio

.72 (3)

.35 (1)

-144 (5)

1.47 (4)

.56 (2)

Current Debt Scores

1. Southwest: (1 + 1 + 1 + 1 + 1 + 1) / 6 = 1

2. Alaska Air: (2 + 3 + 2 + 3 + 2 + 2) / 6 = 2.33

3. United: (3 + 2 + 4 + 4 + 3 + 4) / 6 = 3.33

4. Delta: (5 + 5 + 5 + 2 + 4 + 3) / 6 = 4

5. American: (4 + 4 + 3 + 5 + 5 + 5) / 6 = 4.33

It has never come close to happening before, but Southwest managed to rank the highest in all six debt categories, leaving it with a perfect score of 1. This was over a point better than second place Alaska Air, which had a score of 2.33. The high variation continues, as we have to drop another full point to reach the third place score of 3.33 held by United. This also marks the territory where scores go from better than average (under 3) to worse than average (over 3). Lagging behind in fourth and fifth place are Delta and American, whose scores are 4 and 4.33, respectively.

Profitability

DAL

LUV

AAL

UAL

ALK

Gross Profit Margin

52.32% (5)

73.65% (1)

62..00% (2)

60.13% (3)

52.98% (4)

Operating Profit Margin

11.85% (2)

14.60% (1)

5.97% (5)

7.97% (3)

7.78% (4)

Net Profit Margin

8.86% (2)

11.22% (1)

3.17% (5)

5.14% (4)

5.29% (3)

Profit Per Employee

$60,810 (1)

$54,523 (2)

$20,979 (5)

$36,215 (3)

$31,858 (4)

ROA

6.9% (2)

9.60% (1)

2.49% (5)

5.42% (3)

4.04% (4)

Effective Tax Rate

23.61% (3)

22.12% (2)

25.09% (4)

20.09% (1)

25.30% (5)

Current Profitability Scores

1. Southwest: (1 + 1 + 1 + 2 + 1 + 2) / 6 = 1.33

2. Delta: (5 + 2 + 2 + 1 + 2 + 3) / 6 = 2.5

3. United: (3 + 3 + 4 + 3 + 3 + 1) / 6 = 2.83

4. Alaska Air: (4 + 4 + 3 + 4 + 5) / 6 = 4

5. American: (2 + 5 + 5 + 5 + 5 + 4) / 6 = 4.33

Southwest had another extremely strong showing, almost pulling of all 1's yet again. Since it did so well, a lot of ground was left to make up for the other airlines. In second place is Delta with a 2.5, whose profitability was a strong improvement from its poor debt score. Just behind Delta is United, which managed to sneak across the 3 mark, while Alaska Air came in fourth place with a 4. Remaining at the bottom again is American, which posted an identical score to the debt category - 4.33.

Efficiency

DAL

LUV

AAL

UAL

ALK

ROE

30.03% (2)

25.29% (3)

75.17% (1)

23.37% (4)

12.12% (5)

ROIC

10.32% (2)

13.48% (1)

3.53% (5)

9.48% (3)

5.45% (4)

Asset Turnover

.78 (3)

.86 (2)

.78 (3)

.92 (1)

.76 (5)

Capital Expenditure Ratio

8.59 (3)

11.12 (1)

7.46 (5)

9.89 (2)

8.05 (4)

Employee Cost per Unit of Revenue

.315 (2)

.399 (5)

.309 (1)

.315 (2)

.322 (4)

Revenue Per Employee

$513,354 (1)

$373,554 (4)

$351,824 (5)

$454,378 (2)

$409,453 (3)

Current Efficiency Scores

1. Delta: (2 + 2 + 3 + 3 + 2 + 1) / 6 = 2.17

2. United: (4 + 3 + 1 + 2 + 2 + 2) / 6 = 2.33

3. Southwest: (3 + 1 + 2 + 1 + 5 + 4) / 6 = 2.67

4. American: (1 + 5 + 3 + 5 + 1 + 5) / 6 = 3.33

5. Alaska Air: (5 + 4 + 5 + 4 + 4 + 3) / 6 = 4.17

Claiming one of the four top spots in this analysis is Delta - managing to do so in the efficiency category with a solid score of 2.17. Trailing just behind is United, which scored marginally lower with a 2.33. Even though Southwest scored much lower than it did in the last two categories, it was still left with a strong 2.67. Making up the bottom two stocks again are American and Alaska Air, marking yet another occurrence of American performing below the rest of the group.

Growth

DAL

LUV

AAL

UAL

ALK

EPS Growth

4.05% (3)

23.56% (1)

-30.93% (5)

5.1% (2)

-28.69% (4)

Revenue Growth

12.11% (3)

8.26% (5)

10.85% (4)

12.99% (2)

39.34% (1)

Debt Growth

33.57% (5)

-2.48% (2)

.53% (3)

25.23% (4)

-29% (1)

Free Cash Flow Growth

-54.9% (4)

35.93% (1)

-1300% (5)

-13.58% (2)

-25.10% (3)

Working Capital Growth

4300% (1)

737% (3)

31.11% (4)

738% (2)

-67% (5)

Current Growth Scores

1. Southwest: (1 + 5 + 2 + 1 + 3) / 5 = 2.4

1. United: (2 + 2 + 4 + 2 + 2) / 5 = 2.4

3. Alaska Air: (4 + 1 + 1 + 3 + 5) / 5 = 2.8

4. Delta: (3 + 3 + 5 + 4 + 1) / 5 = 3.2

5. American: (5 + 4 + 3 + 5 + 4) / 5 = 4.2

With its growth score, Southwest returned back to the top with score of 2.4, tied with United, which also had another impressive showing. Alaska Air was able to obtain an above average score, contrary to the profitability and efficiency categories. In fourth place was Delta, and although the score of 3.2 wasn't terrible, it still left plenty of ground to make up. Finally, there's American, which took last place yet again and also didn't do better than a score of 4 in any category.

Final Scores

After implementing performance-based weighting to each category, I have determined that the debt ratios are most correlated to price performance, followed by growth, profitability, and efficiency. Therefore, instead of the equation for finding the cumulative score of a stock looking like this...:

(Debt Score x .25) + (Profitability Score x .25) + (Efficiency Score x .25) + (Growth Score x .25) = Final Score

... it now looks like this:

(Debt Score x .30) + (Profitability Score x .24) + (Efficiency Score x .19) + (Growth Score x .27) = Final Score

With this weighting, more value is given to categories with the greatest correlation to price performance, which, in turn, should lead to more accurate final scores. To answer any lingering questions about how I determine weighting, please see my article that introduces the concept. Here are the most recent weight-adjusted scores for the airline industry:

  1. Southwest - 1.77
  2. United - 2.77
  3. Delta - 3.08
  4. Alaska Air - 3.21
  5. American - 4.10

Southwest blew the competition away in this analysis, scoring well in every single category - even placing 1st in all ratios in the debt category. This makes me rethink the current position I have in Delta. However, I want to get one more year of data to see if either company has a promising or discouraging trend year over year. Once I have this information, I will feel more comfortable about switching my airline allocation to Southwest (or putting money in both if each score improves). United also did surprisingly well, and since its worst score was in the debt category, which has the most weight, there is potential for the company's score to greatly improve if it makes up some ground against Alaska Air and Southwest.

Delta disappointed me a little bit, as going into this analysis, I thought it would place higher. The airline had some quality scores, but a score of 4 in the debt category definitely hurt its chances of being in one of the top two airlines in my research. Alaska Air was kind of all over the place, scoring well in the debt and growth categories, while struggling in profitability and efficiency. I don't think it has to worry about dropping below American, but in order to slide past Delta, the airline needs to improve its score by slightly over 1/10th. There was nothing promising to say about American's score, as it places terribly in all four categories. It's hard to imagine its relative ratios could get worse moving into next year, but I would have to complete a more fundamental analysis to have any ideas on the future prospects of the company.

Year-to-Date Performance

I always include the YTD performance of each stock in my analysis. It's only two months into the year, so there isn't much value behind any of the numbers, especially since my aim is to make it a long-term project. Regardless, it helps visualize where things are at.

Score Rank YTD Return (%)
Southwest 1.77 1 25.15%
United 2.77 2 8.79%
Delta 3.08 3 4.37%
Alaska Air 3.21 4 8.42%
American 4.10 5 9.4%

Conclusion

Since this is the first year I have data for these airline stocks, I couldn't do any comparisons to past year's scores. Nevertheless, data needs to start somewhere, and this year will act as the baseline. For my next few articles, I plan on updating some of the analyses that have a couple years of data behind them, allowing for me to start seeing some 3-year trends of scores, which I believe will be very informative.

Additionally, I received some thoughtful feedback on my previous article, which suggested accounting for a couple of different factors. The factor I am going to try to include in my next analysis is the rate at which companies buy back their stock. A stock with greater buybacks will benefit, and it's undecided if stocks with lower/no buybacks will be penalized or have their score simply remain the same. I'll be testing out a few different methods to see which ones seem to work best, and will update everyone when I think I find something that fits. As always, any feedback or insights are more than welcome.

Disclosure: I am/we are long DAL. 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.