Alaska Air Doing Its Part, But Investors Seem More Nervous About Airlines

Alaska Air (ALK) did its part, and a little more, for the fourth quarter, and guidance for 2019 looked fine, but I suspect investors didn't like management's comments about recent volatility in fares, and I think concerns related to the ongoing government shutdown are playing into the stock as well. While I do believe Alaska Air is undervalued and well-positioned to generate above-average growth in 2019 as it leverages the benefits of the Virgin deal and pursues some new ancillary revenue opportunities, a weaker economy and a more competitive airline sector loom as risks, and investors shouldn't underestimate the challenge it can be to outperform a weaker sector.

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Alaska Air Doing Its Part, But Investors Seem More Nervous About Airlines

After A Year Of Heavy Lifting, Alaska Air Looks To Get Back To Business

This was a challenging, and likely frustrating, year for Alaska Air (ALK) management, as the company still had a lot of the heavy lifting to do in integrating the Virgin acquisition, but didn’t really get to see the benefits yet. At the same time, competitive actions from other airlines like Delta (DAL), United (UAL), and Southwest (LUV) have made managing capacity in the company’s key West Coast markets a little more challenging. All told, then, it’s been a challenging year for the stock (down about 15%), though Alaska Air has fared better than the sector as a whole.

I was lukewarm on Alaska Air back in June mostly due to sentiment and the risk of further negative earnings revisions. The shares are down slightly since then, while EBITDA expectations have fallen about 10%. I believe that sets the stage for a better 2019, and I believe Alaska Air is poised to generate some of the best growth in earnings spread (the difference between RASM, or revenue per available seat mile, and CASM, or cost per available seat mile) in the sector, as Alaska Air gets back to its normal operating prerogatives. A weaker economy and a less disciplined sector are still threats, but I believe Alaska Air should be trading in the $70s today.

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After A Year Of Heavy Lifting, Alaska Air Looks To Get Back To Business

Alaska Air Fighting Some Competitive Headwinds

I described myself as “cautiously bullish” on Alaska Air (NYSE:ALK) earlier this year, as I was concerned that the generally positive long-term outlook for this well-run airline could be overshadowed by near-term cost/synergy and competitive capacity worries, not to mention overall late-cycle weakness in airlines. Shares have lost a little ground since then, more or less keeping pace with Delta Air Lines (NYSE:DAL) and bracketed by Southwest (NYSE:LUV) and JetBlue (NASDAQ:JBLU) on the weaker end and United (NYSE:UAL) on the better-performing end.

My basic outlook on Alaska Air really hasn’t changed that much. Higher labor costs and fuel costs are a drag on results, but management seems to be switching back to a network optimization footing, and history suggests that will generate some positive results for shareholders. I’ve been concerned for a little while that a prolonged stretch of good behavior from airlines would eventually end, and I think that may be happening now with capacity growth along the West Coast. Even so, I think low-to-mid single digit growth from Alaska Air can support a fair value above $70 and double-digit total annualized returns from here.

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Alaska Air Fighting Some Competitive Headwinds

Alaska Air Undervalued On Uncertainty

It's been a while since I've written on Alaska Air Group (NYSE:ALK) and a lot has changed since then. A company praised and valued for going its own way and sticking to a different plan than many of its rivals is trying to go down the familiar route of growth through M&A. With that, the company is taking on risks tied to the deal approval process, integrating the two businesses, mixing up its fleet, and possibly wrecking the things that made merger target Virgin America (NASDAQ:VA) distinct and popular.

I do think there are valid concerns regarding the Virgin America deal, not to mention ongoing concerns about competitive capacity increases and pressures on yields. Outside of Virgin America, none of these concerns are new, though, and I think management here has earned the benefit of the doubt. I'm taking a cautious view on valuation given the present uncertainties, but Alaska Air still looks at least 10% undervalued on that basis, with more upside that can be driven by solid execution on synergy targets and/or less onerous conditions for deal approval.

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Alaska Air Undervalued On Uncertainty

Seeking Alpha: Alaska Air Thriving In More Crowded Skies

Alaska Air Group (NYSE:ALK) was supposed to get walloped in 2014, as Delta Air Lines (NYSE:DAL) aggressively expanded its Seattle-based operations, pressuring revenue and margins for the smaller regional carrier that relies upon Seattle as a major hub. As it happened, though, Alaska Air had a pretty good year from a revenue, margin, and stock performance perspective as careful cost management, revenue enhancement, and competitive efforts paid off.

It's tough for me to call Alaska Air a great bargain today. I think it is an exceptionally well-run airline and I like the prospects for higher payouts as the company returns surplus cash to shareholders. While the shares do seem undervalued on the basis of next year's projected EBITDAR, it takes an averaged double-digit FCF margin over the next decade to support a low-to-mid $70's fair value by discounted cash flow and that's more aggressive than I'm comfortable with from an airline. That said, investors don't seem to often buy or sell airlines on the basis of long-term cash flow, so more aggressive investors may still find a good trading opportunity here.

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Alaska Air Thriving In More Crowded Skies

Seeking Alpha: Alaska Air Still Different, Still Undervalued

I'm not sure any industry has a worse long-term reputation than airlines, but given that it is not so long ago that about 70% of the U.S. airline industry was in bankruptcy I'm not sure you can argue that reputation is undeserved. With that, I think the market has always waited in expectation for the other shoe to drop on Alaska Air Group (ALK), but the company stubbornly continues to out-execute and show that there is a better way to run an airline business.

Certainly Alaska Air is no longer any sort of hidden gem. The shares are up more than 80% over the past year, more than 500% over the past five years, and up almost 1,000% from the mid-2008 low. The company is facing more competition in some of its key routes, but returns and margins remain solidly above-average. I'm not naïve enough to believe that Alaska Air will ever get its full due, but I do still see some additional potential in these shares.

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Alaska Air Still Different, Still Undervalued

Investopedia: Will SingAir's Pain Become Delta's Gain?

Plenty of investors, analysts and commentators have noted that the airline business is fundamentally lousy and one of the fastest routes to losing large amounts of money. There's ample evidence that that is more than just simple grousing over sour grapes - Warren Buffett's Berkshire Hathaway (NYSE:BRK-A) has struggled to make any real profits from its various investments in the sector, and even the well-respected Singapore Airlines (OTC:SINGF) has seen its nearly $1 billion investment in Virgin Atlantic do it almost no good at all. Now there are stories that SingAir is ready to cut its losses, and that American air giant Delta Airlines (NYSE:DAL) is eager to pick up the asset.

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Investopedia: Alaska Air Almost Too Good To Be True

Airlines have built a well-deserved reputation for being terrible investments. Not only does the industry have high ongoing capital demands, but a tradition of beggar-thy-neighbor operating philosophies that lead to cut-throat pricing and minimal (if not negative) real returns across the industry.

And then there's Alaska Air (NYSE:ALK). This is an unusual airline in so many ways. Although it covers a huge geographic footprint (from Alaska to Hawaii to the continental U.S. to Mexico), it's relatively focused in terms of airports and routes served. In an industry where customer loathing is palpable and employee-employer relations harken back to the French Revolution, Alaska Air seems to actually be well-liked by both fliers and those doing/supporting the flying.


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Investopedia: AMR - No Bankruptcy Today ... Yet

"The rule is, jam to-morrow and jam yesterday-but never jam to-day." Carroll, Lewis. "Through The Looking Glass"

Airlines are lousy businesses. Even heralded success like Southwest Airlines (NYSE:LUV) and Ryanair (Nasdaq:RYAAY) have plateaued in recent years, and the airline industry has bedeviled otherwise successful investors like Warren Buffett. Now, with rumors swirling around about financial difficulties at AMR (NYSE:AMR), the financial health of the industry is getting another skeptical look from the market.

The Latest Troubles 

AMR, better known as American Airlines, actually has a relatively rare distinction to its credit. This is one of the few airlines that has not gone bankrupt. Still, with the company seemingly left out in the cold in the merger wave, that saw Northwest absorbed into Delta Air Lines (NYSE:DAL) and the merger of United and Continental into United Continental (NYSE:UAL), there have been worries for some time now that the company would struggle to compete. 

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HEICO Flying

Sometimes it pays for investors to turn over a lot of rocks. Aerospace parts and electronic components maker HEICO (NYSE:HEI) does not get a lot of attention and seldom makes the headlines of the major financial press, but that has not kept the company from doing a consistently good job of generating returns on capital or overall growth. With the airline industry in better health these days, investors have taken notice of HEICO's positive qualities and pushed the stock up more than 75% over the past year. 

Another Good Quarter
HEI delivered a solid end to its fiscal year, with quarterly revenue growth of about 18% that topped the high end of analyst estimates. The company's flight support business (the parts business) saw top line growth of 14%, while the electronic technologies division posted 27% reported growth and 7% organic growth. There was no real magic bullet to the growth in this quarter, rather it was more a product of improving markets and the company's execution.

HEI also did well in moving that extra revenue through to higher profitability. The company saw gross margin improve by more than 200 basis points, though higher SG&A spending depleted some of that benefit. Overall, operating income rose 23% for the quarter, as operating margin improved by about 70 basis points. Growth was relatively balanced between the two segments (flight support up 28%, electronics up 20%), though the electronics business is much more profitable as a percentage of sales. (For more, see The Bottom Line On Margins.)

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