Tailwinds Should Lift Alaska Air

2/17/2014


  Recent Price
$78
  Dividend
$0.80
  Yield
1.0%
  P/E Ratio
14
  Shares (millions)
70
  Long-Term Debt as % of Capital
27%
  52-Week Price Range
$82.08 - $48.30

For decades, the airline industry brought little but frustration for investors, with its labor headaches, overcapacity, volatile fuel expenses, and highly aggressive pricing. It has also performed dreadfully in Quadrix — until recently. Among the 145 industry groups with at least five stocks in our research universe, airlines rank in the top five for Momentum (averaging a score of 73), Earnings Estimates (71), and Overall (76).

That brings us to ask, is this shift sustainable? For now, we believe the answer is yes. The economy is improving, capacity growth seems rational, and cheap financing has allowed airlines to invest in lighter, more fuel-efficient planes.

So how should investors play the airline group? We are taking a conservative approach by picking a high-quality name in the still-risky industry. Alaska Air ($78; ALK) is being initiated as a Buy.

Business breakdown

The company owns two carriers, Alaska Airlines (93% of 2013 operating revenue, 97% of profits) and Horizon Air (7%, 3%). Alaska Airlines ranks sixth-largest among U.S. airlines by revenue and focuses on north-south flights along the West Coast, including service to Alaska, Canada, and Mexico. It also offers flights from eastern U.S. cities to Seattle, its main hub, and to Hawaii. Horizon Air provides regional routes in six U.S. states, five Canadian cities, and two Mexican cities. Alaska Air added 10 new West Coast routes during the December quarter and plans to launch seven flights to Salt Lake City in June.

With a stock-market value of $5.44 billion, Alaska Air is smaller than most of its rivals. But it enjoys superior fundamentals and a balance sheet that contains $1.33 billion in cash, versus $754 million of long-term debt.

Alaska Air posted a net loss in seven of the nine years from 2000 to 2008. But it has ruthlessly cut costs since then while embracing advances in technology. Alaska Air was the first airline to offer online bookings.

Over the past four years, net income has grown at annualized rate of 43%. The company has also reeled off 17 straight quarters of revenue growth and topped consensus profit estimates in each of the past seven quarters. Alaska Air has generated positive free cash flow in each of the last four years and launched a dividend in 2013. Operating momentum carried into the March quarter, as the number of paying passengers rose 4% in January.

The stock still has its risks. Alaska Air has seen increased competition in its key market, Seattle.  And its profits depend heavily on fuel prices, which remain historically high.

Unions dominate Alaska Air's work force, though the horizon appears clear of near-term labor disputes. Last year the company finalized a five-year contract with its pilots and reached a tentative pact with its flight attendants. The current contract with mechanics runs through October 2016.

Despite superior fundamentals and operating momentum, the stock trades at a reasonable 14 times trailing earnings, 36% above their three-year average but a 7% discount to the median for S&P 1500 airlines.

An annual report for Alaska Air Group is available at 19300 International Blvd., Seattle, WA 98188; (206) 392-5040; www.alaskaair.com.

ALASKA AIR
Quarter
Per-Share Earnings*
($)
Sales
Change
Quarterly
Price Range
($)
P/E Ratio
Range
Dec '13
1.10
vs.
0.70
7%
78.53
-
60.26
16 - 12
Sep '13
2.21
vs.
2.09
7%
64.74
-
51.16
13 - 10
Jun '13
1.47
vs.
1.53
4%
68.00
-
50.31
14 - 10
Mar '13
0.62
vs.
0.39
9%
64.55
-
43.32
14 - 9
           
Year
(Dec.)
Sales
 ($Bil.)
Per-Share
Earnings*
($)
Per-Share
Dividend
($)
52-Week
Price Range
($)
P/E Ratio
Range
2013
4.66
5.40
0.40
78.53
-
43.32
15 - 8
2012
4.32
4.73
0.00
45.15
-
31.29
10 - 7
2011
3.83
3.92
0.00
38.57
-
25.55
10 - 7
2010
3.40
3.57
0.00
29.80
-
15.62
8 - 4
 
Quadrix Scores †
Overall
Momen-
tum
Value
Quality
Financial
Strength
Earnings
Estimates
Performance
99
85
81
95
59
79
79

   * Earnings exclude special items.
   † Quadrix® scores are percentile ranks, with 100 the best.


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