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.
Investopedia Markets: Explore the best one-stop source for financial news, quotes and insights.
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.
Reasonable Results, to a Point
Alaska Air's fourth quarter results were respectable. Overall operating revenue rose 9%, as the company logged a 6% increase in revenue passenger miles and a nearly two point improvement in load factor. Passenger revenue per available seat mile rose a little less than 6%, while non-fuel costs were flat.
Fuel was definitely an issue, though. While Alaska Air has a consistent hedging program that limits disastrous cost inflation, fuel costs nevertheless rose 30% and reported operating income fell 4% for the quarter.
SEE: The Economics Of Discount Airlines
A Transition with Little Change
Alaska Air recently announced that its CEO Bill Ayer will retire in May, with company insider Brad Tilden taking over. Given Tilden's experience and tenure with the company, it seems reasonable to assume that little will change in how Alaska Air operates.
And that's a big deal. Alaska Air pursues a different model that seems to deliver real benefits to shareholders. Alaska Air doesn't try to be a national/international airline like United Continental (NYSE:UAL) or Delta (NYSE:DAL). Instead, it sticks to its knitting on the West Coast of the U.S. and focuses on adding profitable routes like those to Hawaii and/or Mexico.
Can This Continue?
At the risk of sounding exceedingly cynical, the best indicator of future trouble in airlines has historically been good results in the present. Once things are going well, airlines often see their rivals crowd in, cut prices or otherwise ruin the good thing they have going. In other cases, airline executives will indulge their own illusions of brilliance and launch expansion plans that fritter away positive returns and ultimately burden the company with unprofitable routes and planes.
There are certainly some risks for Alaska Air. Although Southwest (NYSE:LUV), American Airlines, and United have been trimming back overlapping routes, JetBlue (Nasdaq:JBLU) and Virgin are expanding. Luckily, these are responsible competitors.
There's also the question of whether Alaska Air can maintain good employee relations and responsibly use its capital. As Alaska Air prospers, it's not unreasonable to think that its employees will want to share in the upside and that could ultimately pressure costs. In addition, Alaska Air is very strong from a balance sheet perspective, and while there is a need to renew some of the fleet, what management intends to do with an uncommonly strong balance sheet is likely to emerge as a central theme for the stock.
The Bottom Line
With the stock up about 500% off its March 2009 bottom and returns on capital in the double-digits, it's hard to believe that things can get much better for this airline.
If you assign a forward EBITDA multiple of four times to analyst estimates (and this is well below long-term averages in the airline sector), the suggested fair value is in the mid-$90s. Take current sell-side expectations for free cash flow growth and the target leaps well into the $100s. In fact, even if an investor assumes that free cash flow conversion rates will plunge back to long-term averages in 2014 and thereafter, the stock is still arguably worth something north of $80.
All of this makes for a puzzling decision. One of the closest things to an iron-clad investing rule is to avoid airlines, and yet history has seen, repeatedly, that there are exceptional companies in even the worst of industries. While I certainly have issues believing in any domestic passenger airline story, Alaska Air may yet have a lot of value left to give.
SEE: The Year In Airline Stocks
Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!
At the time of writing, Stephen Simpson did not own shares in any of the companies mentioned in this article.
Mutual Funds & ETFsLearn about arbitrage funds and how this type of investment generates profits by taking advantage of price differentials between the cash and futures markets.
Investing NewsWill Ferrari's shares move fast off the line only to sputter later?
Mutual Funds & ETFsThese three transportation funds attract the majority of sector volume.
Stock AnalysisHere are five stocks that pay safe dividends and should be at least somewhat resilient to a bear market.
InvestingThe further you fall, the harder it is to climb back up. It’s a universal truth that is painfully apparent in the investing world.
Fundamental AnalysisOptions market trading data can provide important insights about the direction of stocks and the overall market. Here’s how to track it.
Stock AnalysisCan these two oil stocks buck the trend?
Investing NewsAlcoa plans to split into two companies. Is this a bullish catalyst for investors?
Stock AnalysisIf you want to buck the bear market trend by going long on consumer stocks, these three might be your best bets.
Investing NewsA rate hike would certainly alter the investment scene, but would it be for the better or worse?
When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>