Two Great Airline Stocks

Up, Up and Away

Alaska Air Group


Investing in airline industry stocks is a challenge.  Airline companies generally have low profit margins, high debt loads and cyclical performance.  The industry is very competitive in the U.S. and overseas, as too many airlines compete for too few travelers.

After consumers and businesses reined in travel spending in 2008 and 2009, travelers are flying once again, which is good news for the airlines. Revenues at airlines in the U.S. are forecast to advance a whopping 17% in 2010, with another healthy increase in 2011. Profits of $3 billion are forecast for 2010 compared to an ugly deficit of $5 billion in 2009.

Airline stocks tend to fluctuate with the health of the economy and the swings in fuel prices. The resulting volatility and high debt levels cause most of the airline stocks to become risky selections. Yet, the wide fluctuations in the prices of airline stocks provide the nimble investor with plenty of opportunities.

The airline industry is poised for a return to profitability this year. Carriers are reporting better summer booking trends, which reflect an economy that is beginning to move slowly forward. Corporate as well as consumer flying is on the rise, a trend that should continue during the next several quarters. Major carriers are neither planning increases in service nor adding jets to their fleets. Productivity and planeloads are improving, and fuel prices have become less volatile and remain at reasonable levels.

Smaller, more-efficient airlines continue to gain market share from the largest airlines. Low-cost airlines, such as Southwest, JetBlue and Alaska Air, are forcing ticket prices to remain relatively low. Many of the major airlines have merged during the past decade to save costs and become more profitable. UAL, parent of United Airlines, and Continental are likely to merge soon.

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Alaska Air Group (ALK), based in Seattle, operates Alaska Airlines, which contributes 81% of the company’s total revenues, and Horizon Air Industries, which makes up the other 19%.  The Alaska division is a major airline serving destinations along the Pacific Coast, Alaska, Hawaii, Canada and Mexico.

The Horizon Air division is a regional carrier, which complements Alaska Air with connecting flights to smaller cities using smaller, more efficient planes.

J.D. Power rated Alaska Air the “Highest in Customer Satisfaction” for the third year in a row in 2010. In addition, the company has held the top spot for on-time performance for 13 of the last 14 months.

Alaska Air has completed its transition to an all-Boeing fleet composed of 115 jets with an average age of 7.5 years. Horizon is in the process of transitioning to an all-Bombardier Q400 turboprop airplane fleet with a current average age of 5.8 years. Alaska Air recently signed multi-year contracts with its pilots, flight attendants, and mechanics.

Revenues increased 16% and EPS tripled during the quarter ended 6/30/10 boosted by fuller planes, lower costs, higher ticket prices and flights to new cities. We expect 25% EPS growth during the next 12 months as the company expands its service to Hawaii and Mexico and closes less profitable routes. At 8.5 times our 12-month forward earnings per share estimate of 5.85, ALK shares are a real bargain at the current price.

Another smaller airline that we follow, SkyWest (SKYW), is one of the largest commuter airlines. The company provides short-haul service to 218 cities in the U.S., Canada, Mexico, and the Caribbean. Connecting flights are operated as Delta Connection and United Express under arrangements with Delta and United Airlines.

The company recently ended its affiliation with Midwest, which will have little effect on SkyWest’s earnings. Delta and United control SkyWest’s scheduling, ticketing, and pricing and receive a percentage of revenues. SkyWest is reimbursed for most fuel costs. The company is in litigation with Delta concerning expense reimbursements, but we doubt future arrangements between the two airlines will be jeopardized.

SkyWest announced recently that it has entered into a definitive merger agreement with ExpressJet Holdings. Atlantic Southeast Airlines, SkyWest’s wholly owned subsidiary, will acquire all of the outstanding common stock of ExpressJet Holdings for a net purchase price of approximately $133 million cash. ExpressJet Airlines serves 135 scheduled destinations in North America and the Caribbean with approximately 1,400 departures per day. The company provides commuter flights for United and Continental, private charter flights and third-party ground handling services.  

The pick-up in airline travel is now beginning to show its effects as evidenced by SkyWest’s 9.2% increase in passenger revenue miles during the two-month period ending 5/31/10. SKYW has over $12 per share in cash ready to expand its operations. The company added new contracts with AirTran and expanded its agreements with United Airlines. SkyWest will likely win additional new business during the next few quarters. The company is interested in adding routes to Asia. EPS will probably increase by a minimal amount in 2010 followed by a 15% EPS surge in 2011.

SKYW shares are undervalued at only 0.50 times current book value and 7.9 times EPS. We foresee major changes in the airline industry that will favor commuter carriers such as SKYW. The company’s dividend yield of 1.3% is attractive. SKYW shares are volatile, but well worth a look.

Today’s Cabot Wealth Advisory is dedicated to my son, Kurt.


J. Royden Ward
For Cabot Wealth Advisory

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