Finding Strength in Small Airlines

Nathaniel is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The airline industry has performed very well as of late in line with the broader market. Over the last few years the industry has experienced great consolidation, and operating efficiencies which have allowed these companies to generate profits during historically unprofitable times. In this article I would like to highlight a few investment opportunities within the airline sector you may have passed over previously. These companies all are attractively valued with operations within targeted regions as opposed to the entire sector.


The first company I would like to take a look at is Hawaiian Holdings (NASDAQ: HA) the holding company for Hawaiian Airlines. While the company initially provided the niche transportation routes to Hawaii, the company has expanded its presence greatly, both domestically and internationally, over recent years. As of recent data, the company ranks eleventh in terms of scale, but sports the number one ranking when it comes to on time performance.

Over the last year, the company has worked to increase its revenues by 19% while decreasing operating costs by nearly 8%. While most airlines carry a high degree of commodity and currency risk, the management of Hawaiian Holdings has proactively managed exposure through extensive hedging partnerships covering the majority of inputs.

If you compare Hawaiian Holdings to its large counterparts on a valuation basis you see the company is undervalued by conventional measure. The enterprise value to EBITDA multiple sits at 3, when typically its competitors carry much higher multiples around 5. On a price to book basis, the company looks inexpensive with a multiple of only 1.2. Going forward, book value should continue to improve as the company focuses less on expanding into under performing markets and more on paying down its debt related to its fleet. 

Next up, Allegiant Travel Company (NASDAQ: ALGT). The low cost airline has performed exceptionally well so far this year with a return over 40% year to date. The company is able to achieve below market inputs through a variety of risky, but rewarding strategies. In order to save capital, the company looks to purchase used planes, charge passengers above average fees for below average luxuries, and avoid hedging its commodity and currency exposure. The advantage the company holds is its ability to meet demand in smaller and mid-sized airports where the large players have avoided.

By avoiding additional infrastructure  the company can afford to offer services in small airports while maintaining strong margins. The company takes in unheard of 40% gross margins, well above that of the rest of the industry by avoiding middle man discounters and frequent flyer programs. When you consider the company's astounding growth of 47% just last quarter, the 16 times forward earnings multiple seems attractive. The PEG ratio sits below 1, a signal shares are undervalued in regards to growth.  

Alaskan potential 

Alaska Air Group (NYSE: ALK) is well off the highs seen earlier this year, yet has performed very well year to date with a return of 20%. The company has worked hard to improve its operating inefficiencies through a series a initiatives including higher capacity planes and higher frequency on popular routes.

In a partnership with American Airlines, the company has recently opened an additional revenue stream via an expanded code sharing agreement. The agreement will allow American's frequent fliers to use their rewards on 22 of Alaska's routes including the West coast to Hawaii, the Pacific Northwest, San Diego to Boston and Orlando routes. Passenger traffic has been rising steady, 9% as of the last quarter, led by an increase in flying capacity of 8.7%. With a PEG ratio of only 0.80 and a forward multiple of only 8, the company's future potential looks cheap considering an analyst expected growth rate of 15% next year. 

Wrap up

In the years ahead it likely the airline industry will experience continued consolidation. I am looking at the smaller airlines to benefit from this consolidation. All three of the companies look inexpensive on a valuation basis in comparison to the entire industry, thus making an acquisition beneficial to the larger players. 

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Nathaniel Matherson has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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