Allegiant Air in the Clouds, Fundamentals Firmly Grounded
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Ever since deregulation in the late '70s, one of the strongest areas of growth in the airline industry was in low-cost carriers. Southwest (NYSE: LUV) was one of the first, shuttling customers around the country in an all-economy cabin configuration and serving them only peanuts. JetBlue (NASDAQ: JBLU) made the experience better with in-flight TV screens and transcontinental flights and Spirit (NASDAQ: SAVE) charges bargain-basement fares and runs brash ad campaigns. One carrier, Allegiant (NASDAQ: ALGT), has put a new spin on the discount carrier concept.
First, it has a sharp focus on leisure travelers. Allegiant shuttles people living in regions that are underserved by major carriers in colder, northern climates such as Eugene, Oregon and Bangor, Maine, to warm-weather destinations such as Las Vegas and Tampa, Florida. Southwest and JetBlue, however, focus on point-to-point service between major cities carrying general traffic and lower-end business travel.
Second, the company is dedicated to keeping costs low and keeping up revenue. Allegiant has a fleet of older planes. Most of Allegiant's planes are MD-80s, though Allegiant has added some Boeing 757s for its new service to Honolulu. The planes don't need to constantly earn money by staying in the air, so they don't have to fly every day. This saves on fuel costs, even with the gas-guzzling MD-80 series. Allegiant is also adding Airbus A320s to its fleet.
Allegiant also makes money not only from ticket sales, but also through charging fees for various services, like a recently introduced fee for carry-on bags. There are also various fees when booking tickets on Allegiant's website, like a fee for choosing seats. Alliegiant landed in hot water with the Department of Transportation for not including its "convenience fee" in price quotes on its website. Spirit also fought the rule, losing in court along with Allegiant.
Even if the fees are unpopular with both the travelers and regulators, it's impossible to deny that the fees bring in a lot of money. With a profit margin of 10.81 percent, it's one of the highest in this market segment. Allegiant's closest competitor, Spirit, employs a similar strategy, with a similar profit margin. Alaska, JetBlue and Alaska Airlines (NYSE: ALK) all have profit margins of around 4 to 6 percent. The whole industry, however, seems to be following suit, finding more fees to charge passengers. When you're at 35,000 feet and your're parched thanks to the recirculated air and your stomach's growling, you'll shell out when the food and drink carts come around, too.
Another advantage Allegiant has is in its vertical integration, as the airline sprang out of a travel company. Passengers can book a hotel, a rental car and show tickets at the same time they're booking their flights. This generates even more ancillary revenue for the company.
Allegiant's moat is thus how it gives access to people outside of major metro areas access to cheap flights at low fares, even with the fees.
On the other hand, nearly all the other major airlines do this, including Southwest and JetBlue. Allegiant, however, focuses on selling vacation packages and practically waves these sources of "ancillary revenues" in their customer's faces.
Their strategy seems to be working. Allegiant has conistently turned a profit, and its earnings have been increasing, even if its revenues are somewhat seasonal. Allegiant tends to do particularly well in the summertime, not surprising given its focus on leisure travel, though.
The only caveat is that capital expenditures are a bit high relative to the company's cash flow from operations, resulting in a free cash flow that is lower than it could be, as Seth Jayson pointed out. On the other hand, the airline business is a very capital-intensive one, and Allegiant CEO Maurice Gallagher blamed the increase in a maintenance "bubble" relating to their plane's engines, though the purchase of new planes would no doubt put a dent in capital expenditures.
On the other hand, Allegiant isn't doing too badly. As you can see from the chart below. Allegiant manages to maintain a positive free cash flow, as do most of its contemporaries. Southwest and Alaska are the ones running into trouble, though summer is a big time for travel. Let's see what happens in the 3rd quarter before panicking. Positive cash flow means that these airlines, including Allegiant, have the opportunity to pay more back to investors.
The smart cost savings and vertical integration overall make Allegiant a solid investment, despite the turbulence that constantly plagues the industry.
Fool Blogger David Delony has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend Southwest Airlines. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.