The Truth About the Airline Industry

Featuring Lutts’ Logic:
 
The Secret of Life
 
The Truth About the Airline Industry
 
My Favorite Airline Stock
 

 
“The secret of life is getting up early.”  Gretchen Peters
 
“The secret of life is enjoying the passing of time.”  James Taylor
 
“The secret of life is honesty and fair dealing. If you can fake that, you’ve got it made.” Groucho Marx
 
Groucho, born Julius Henry Marx, was funny, no doubt about it.  But he was a hard worker; he worked from age 12–dropping out of school because the family needed money–until well beyond his 80th birthday.  No doubt he got up early, just as Gretchen Peters advised.  And as James Taylor advised, he enjoyed life, marrying–and divorcing–three women.  As for honesty, the characters he played, noted in particular for their quick wit and ready insults, were an extension of Groucho himself.
 
For example, according to Wikipedia, “Once, at a restaurant, a fan came up to him and said, ‘Excuse me, but aren’t you Groucho Marx?’ ” “Yes,” Groucho answered annoyedly. “Oh, I’m your biggest fan! Could I ask you a favor?” the man asked. “Sure, what is it?” asked the even-more annoyed Groucho. “See my wife sitting over there? She’s an even bigger fan of yours than I am! Would you be willing to insult her?” Groucho replied, “Sir, if my wife looked like that, I wouldn’t need any help thinking of insults.”
 
And once when the family was going through airport customs, Groucho filled out the form by listing his name as “Julius Henry Marx” and his occupation as “smuggler.” Imagine the trouble that caused.
 
One surprise is that Groucho was very well read, a fact that more than compensated for his lack of formal schooling.
 
“I think TV is very educational,” he once said. “Every time someone turns on a TV, I go in the other room and read.”
 
I think Groucho discovered the secrets of life.
 
But I don’t have much more to say about that today.  I just thought a little bit of Groucho would make you smile.  And smiling is a good thing.
 
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Moving along, I noticed the following headline last week:
 
“Virgin Atlantic boss warns no airlines will make money this year.”
 
Reading deeper, the writer informs us, “Steve Ridgway said reduced passenger numbers, ‘massive’ pressure to cut prices and high fuel costs will prevent any of the world’s major airlines, including Virgin Atlantic and British Airways, making a profit in the current financial year.”
 
Hmm, now it’s only “major airlines” that won’t make money.
 
Reading further still, we get to Mr. Ridgway’s actual words:
 
“These are some of the toughest times any of us [airline executives] can remember.  I would be very surprised if anybody made any money.”
 
That’s different still.  So where’s the truth?  I took a look at the consensus of Wall Street analysts’ estimates of ALL publicly traded airline companies, and here’s what I found.  Airlines are presented in order of revenue, biggest first.
 
AMR Corp. (AMR), with revenues of $23.8 billion in 2008, will lose $1.01 per share in 2009.
 
Delta Air Lines (DAL), with revenues of $22.7 billion in 2008, will earn $0.54 per share in 2009.
 
UAL Corp. (UAUA), with revenues of $20.2 billion in 2008, will lose $4.97 per share in 2009.
 
Continental Airlines (CAL), with revenues of $15.2 billion in 2008, will earn $0.33 per share in 2009.
 
US Airways Group (LCC), with revenues of $12.1 billion in 2008, will lose $1.16 per share in 2009.
 
Southwest Airlines (LUV), with revenues of $11 billion in 2008, will earn $0.35 per share in 2009.
 
China Southern Airline (ZNH), with revenues of $8.1 billion in 2008, will lose a penny per share in 2009.
 
TAM (TAM) of Brazil, with revenues of $5.7 billion in 2008, will earn $0.77 per share in 2009.
 
China Eastern Airlines (CEA), with revenues of $5.7 billion in 2008, will lose $0.33 per share in 2009.
 
Lan Airlines (LFL), the big South American carrier with revenues of $4.5 billion in 2008, will earn $0.86 per share in 2009.
 
Ryanair Holdings (RYAAY), with revenues of $3.9 billion in 2008, will earn $0.54 per share in 2009.
 
Alaska Air Group (ALK), with revenues of $3.7 billion in 2008, will earn $2.07 per share in 2009.
 
SkyWest (SKYW), with revenues of $3.5 billion in 2008, will earn $1.03 per share in 2009.
 
Go! Intelligent Airlines (GOL), with revenues of $3.4 billion in 2008, will earn $0.20 per share in 2009.
 
JetBlue Airways (JBLU), with revenues of $3.4 billion in 2008, will earn $0.40 per share in 2009.
 
AirTran Holdings (AAI), with revenues of $2.6 billion in 2008, will earn $1.06 per share in 2009.
 
WestJet Airlines (WJA) of Canada, with revenues of $2.1 billion in 2008, will earn $1.20 per share in 2009.
 
Republic Airways Holdings (RJET), with revenues of $1.5 billion in 2008, will earn $1.95 per share in 2009.
 
Copa Holdings (CPA) of Panama, with revenues of $1.3 billion in 2008, will earn $4.22 per share in 2009.
 
Hawaiian Holdings (HA), with revenues of $1.2 billion in 2008, will earn $1.34 per share in 2009.
 
The remaining public companies either have revenues of under $1 billion or no Wall Street consensus.  These are ExpressJet Holdings (XJT), Allegiant Travel (ALGT), Pinnacle Airlines (PNCL), Mesa Air Group (MESA) and Gulfstream International (GIA).
 
Summing up, of the 20 airlines for which Wall Street has earnings estimates, only five are expected to lose money in 2009.  That’s 24%.
 
More interesting is the fact that every airline with revenues of less than $5 billion last year is expected to be profitable in 2009.  The trouble comes for the bigger airlines, whose legacy costs and debt obligations have proven more difficult to maintain in a contracting economy.  (Shades of GM’s troubles.)
 
Of the nine airlines at the top of the heap with revenues over $5 billion, five are expected to lose money in 2009.  All but one, however, are expected to be profitable in 2010.
 
And if you drop the two Chinese and the Brazilian carrier from that top group and simply focus on the big six, the American airlines, 50% are expected to be profitable in 2009.
 
Granted, the losses in the group are expected to outweigh the gains, but all six are expected to solidly profitable in 2010 and beyond, and I think if they can get a hold on their costs and pricing, the survivors of this contraction phase will be well positioned to make good money going forward.
 
Summing up, conditions do not seem to be as dire as Mr. Ridgway believes … and in no way do they merit the attention-getting headline (which did its job well).
 
There is, in fact, one interesting investment opportunity in the group.
 
It’s Allegiant Air (ALGT).
 
On March 23, I wrote the following here:
 
“Allegiant Travel (ALGT) is a budget airline focused like a laser on the price-sensitive vacationer headed for California, Las Vegas, Phoenix, Florida or South Carolina.  Now, mention airlines to most investors today, and they’ll say, “No thanks.”  Everyone knows the airlines are in rough shape.  Demand has fallen off the cliff.  All the big guys are cutting flights, mothballing planes in the desert, and offering rock-bottom fares to fill the seats in the planes still flying.
 
But that’s exactly why now might be the best time to invest in an airline!  So let’s look at Allegiant.
 
Headquartered in Las Vegas, the airline was founded in 1997.  It’s grown revenues every year of this decade, and in the fourth quarter of 2008, when every major airline was crying its eyes out, Allegiant saw revenues grow 21% from the year before to $122 million.  Perhaps more impressively, it even saw revenues grow from the third quarter to the fourth quarter!
 
Most impressively, its after-tax profit margin was a plump 14.9%!
 
So how does Allegiant do it?  It flies from small cities to those vacation spots, so fees are lower at one end.  Competition is lower too.  It flies only MD80s, thus minimizing complexity.  And it partners with hotels, vacation planners, car rental firms and vacation planners to offer low-cost package deals.
 
So it’s a classic growth story; the little upstart, with bare-bones overhead, coming in to steal business from the big old companies who simply have too much overhead, and can’t get their costs down to compete.
 
Also, the fact that the stock is young and little-known means it’s much more subject to potential buying power than potential selling power.  At last count, the stock was owned by only 57 mutual funds, while Southwest (LUV) was owned by 295 and Delta (DAL) was owned by 198.
 
The chart is the main reason the stock came to our attention in the first place, and here’s what we see today.  ALGT came public in late 2006 at 24, peaked at 39 in late 2007 and bottomed at 16 in July 2008, four months before the market crash.  It then ran all the way up to 49 at the end of 2008, and since then it’s been digesting that gain.  Most recently, it’s been building a base at 40, and if you like the story, you could nibble on a few shares here.”
 
Since I wrote that on March 23, the stock has been up to nearly 58 (at the market’s short-term April peak).  And now it’s pulled back to 40, trading rather tightly there over the past week, and sitting right on top of its 200-day moving average.  I think it’s a low-risk buy here, though there’s a chance it could go as low as 32.
 
Also since then, the company has reported first quarter results.  Revenues were up 7% to $142 million, while earnings jumped 191%, from $0.47 to $1.37.  The after-tax profit margin was a whopping 19.8%.  For the year, analysts are estimating that Allegiant will earn $4.62 per share.  And now 74 mutual funds are on board.
 
Yours in pursuit of wisdom and wealth,
 
Timothy Lutts
Publisher
Cabot Wealth Advisory

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