If you want to be a Millionaire, start with a billion dollars and launch a new airline. – Richard Branson
It wasn’t that long ago where airlines were the butt of the joke.
Fixed costs were too high and continued to go up, margins were razor thin, constant bad press and too much competition.
At this year's inaugural London Quality Growth Investor conference, Denis Callioni, analyst and portfolio manager at European investment group Comgest, highlighted one of the top ideas of the Comgest Europe Growth Fund. According to the speaker, the team managing this fund focus on finding companies that have stainable growth trajectories with a proven track record Read More
Airlines took it to the gut over the past century.
Warren Buffett joked "...the airlines had a bad 20th century. They're like the Chicago Cubs. And they got that bad century out of the way, I hope".
Over the past 10 years, the airline industry has gone through dramatic shifts in how business is operated. Consolidation has enabled companies to profit and changed the finances of airlines. Once money bleeding companies are now in the black. Demand is higher as people have extra money and more people take to the skies to travel. Airlines have gotten creative with how they pinch consumers. New baggage fees, upgrades for certain seats and spaces, and the ever-growing industry of selling miles are money makers for airlines.
Given the perception of the airline industry being cutthroat, unprofitable and risky, it's a surprise to see airline stocks show up in our version of the Magic Formula screen.
Are Airlines Cheap Magic Formula Stocks?
Rather than being limited by Greenblatt's Magic Formula screener, we've created our own rendition at Old School Value.
We've added some basic criteria to the mix in order to find an investable universe.
Here's what we are filtering to find Magic Formula Stocks.
- Enterprise Value to EBIT (EV/EBIT) between 0 and 15
- ROIC between 0% and 50%
- Magic Formula Earnings Yield between 0% and 50%
- Market Cap greater than 700M
- Company sector excludes financials, utilities, REIT's
- Margin of Safety using EBIT Multiple valuation is greater than 20%
The first page of results show 4 airline stocks.
- Hawaiian Holdings (HA)
- Alaska Air Group (ALK)
- Spirit Airlines (SAVE)
- Allegiant Travel (ALGT)
Of the four airline stocks, put them side by side and there is one clear winner worth investigating based on value.
Allegiant Travel (ALGT)
The best position to be in as a player in air travel is to be a low cost provider. It's not everyday you see an airline up 400% since going public in 2007.
To date, only Alaska Air has outpaced Allegiant in terms of stock appreciation having gone up 540% during the same period.
By sticking with smaller and profitable routes, Allegiant Travel has been able to hit the Magic Formula conditions with the following numbers.
- EV/EBIT of 9.8
- ROIC of 16.5%
- Magic Formula earnings yield of 10.21%
- Market cap of 2B
- Quick EBIT multiples fair value says it has a 22% margin of safety
The Amazing Growth Story
Allegiant has 405 routes and 89 aircraft in their fleet serving small to medium sized cities which the bigger airlines can't support. No matter what type of market, there are always black spots that need filling.
One example is how Hibbert Sports (HIBB) held strong advantages in small to mid sized markets pre-internet. This is a retailer that was once profitable for 30 years. Completely different story now. However, Allegiant Travel holds business advantages that another company in a different industry like Hibbert Sports could never achieve.
Today, the internet is killing retail stores that cannot adapt, but on the flip side, the internet has made it easier for people to book and plan travel online. Social media and people sharing where they are or traveling to, increases the desire to travel. As disposable income increases, people like to enjoy themselves. It's not a surprise to see the surge in passports being issued.
Catastrophic events happen, but travel always picks back up.
Allegiant competes with other low cost carriers like JetBlue (JBLU), Spirit Air (SAVE) and Southwest (LUV), but they differ themselves by targeting leisure travelers. They do the usual business of selling flight tickets on a stand-alone basis and bundled with hotel rooms, rental cars and other travel related services.
Here are some extra strategies Allegiant uses to bring in business.
- Focuses on the leisure traveler instead of business travelers. Leisure travelers want cheapest airfares first and schedule their trip around their flight itinerary. Business travelers place great importance on their own business schedule with price coming second. This strategy allows ALGT to provide low frequency services from small cities but makes full use of capacity.
- Every flight is a direct flight. No connecting flights.
- There is only a limited number of destinations they fly to. Mostly Daytona Beach, Orlando, Las Vegas, Phoenix, Tampa Bay.
- Focuses on markets where competitors will find it difficult to enter. The bigger airlines will have to accept losing money in these markets if they want to compete for market share.
- Does not fly out every day. The traveler must accommodate their schedule to match what Allegiant offers.
The newest strategic development is that Allegiant is now trying to become a leisure brand, rather than an airline. Instead of just settling for a single transaction with the consumer, the first page of the last investor presentation states 5 key points.
- Create and establish leisure brand
- Part of the customer experience not the transaction
- Integrate more of the travel experience
- Build more touch points for interaction with customer
- Participate in beyond airline revenue
The resort they are planning to build in Port Charlotte will be fully owned and operated by the company. Based on their surveys and data analysis, here are some sales interest they've gathered for the condos that will up for sale.
The Buffett effect drove up airline stocks last November as he took positions in American Air (AAL), United Continental Holdings (UAL), Delta (DAL) and Southwest (LUV). After all, 2016 was a great year for airlines.
Since starting 2017, numbers for Allegiant are coming in softly. Total Revenues per Available Seat Mile (TRASM) has dropped this year and recent hurricanes and the Las Vegas shooting have hampered results with lower bookings in Q3 which is traditionally a seasonally weak period. Management is projecting that TRASM will be down between -3% to -0.5%. Could be lower considering the highest capacity of flights for Allegiant go to Florida and Las Vegas.
The bright side is that Q4 books are going back up and it won't seem to affect Q1 of 2018.
Financially, as Allegiant speeds up the process of replacing their old MDA fleet with Airbus models, a lot of money is being poured into acquiring planes, maintenance and training the staff.
You see that in the numbers.
Although revenue in the last quarter was up 3.2% compared to Q3 a year ago, gross profit is down 14%, operating expenses has shot up 19%, bringing operating profit diving 44%.
Is Now A Good Time to Buy Allegiant?
In short, no.
It looks cheap and has good Magic Formula numbers but the criteria for a buy is to see whether it is better than an existing holding. Although the history of success is there, there's a shift in the business direction that is yet to be seen. Operating resorts are a tricky and highly capex heavy business. It is going to take a year or two for Allegiant to prove itself through the numbers, and until then, it's a better idea to hold off.
If you believe that this is the low point of the company, then now may be a good time to enter, provided you can buy and ignore stock prices for at years 3 years.
Fears or Risk?
Lastly, here are some fears or risks that should be accounted for.
The following are not all valid, but something to think about.
- Coming off the low oil prices will increase expenses
- Higher fuel costs increase price for cost sensitive consumers
- People move out of small to mid cities
- War and terrorist threats kill air travel
- Plane crashes scare people away from air travel
- More shootings in travel destinations create fear of travel
- Current earnings yield of 10% is too good to be true going forward. The industry is still broken.