Alaska Air Takes Flight

03/15/2019 5:00 am EST

Focus: TRANSPORTATION

Ian Wyatt

Publisher & Chief Investment Strategist, Wyatt Investment Research

2018 was a choppy year for the airline business; high oil prices weighed on earnings for much of the year, while investors were also pricing in an elevated recession risk, asserts Ian Wyatt, editor of Million Dollar Portfolio.

US Global Jets ETF (JETS), which owns stocks in 33 global airlines, is a great example of last year’s turbulence. It made some strong upward moves, but had a hard time maintaining momentum.

Our own recommendation — Alaska Air Group (ALK) — was no exception, only gaining about 0.5% over the course of 2018. Like every other airline, it suffered from high oil prices and shaky investor confidence. It was also dealing with its Virgin America merger, announced in 2016.

Virgin continued to operate its own flights until last April. And flight crews are still being trained on Virgin's Airbus A321s and Alaska Air’s Boeing fleet.

Operationally speaking though, 2018 wasn’t a bad year for Alaska Air Group. Fourth-quarter net income came in at $23 million, which was on the low side because of merger-related costs.

Excluding those costs, net income would have been $93 million, well ahead of the $88 million from the same period last year. Full-year net income totaled $437 million, though it would have been $554 million excluding merger costs.

Alaska Air’s passenger revenue grew by 6% in the quarter, and by 5% over the full year. Revenue per available seat mile (RASM) was also up 5.2% in the quarter, its biggest jump in several years. Impressive as that is, the airline also repurchased 776,186 shares of stock and paid down debt. It reduced its debt-to-capitalization ratio to 47%, compared to 53% in 2017.

The icing on the cake was a 9% increase in Alaska Air’s quarterly dividend, up from $0.32 to $0.35 per share. The bump was funded through strong free cash flow. Operating cash flow was $1.2 billion for year, but Alaska used only about $960 million for capital expenditures. That left $240 million of free cash to be distributed to investors.

While Alaska Air Group isn’t the biggest airline, ranking fifth in terms of market share, that was one of the strongest performances in the industry.

Alaska Air’s guidance for 2019 also looked extremely positive. Alaska Air expects RASM to grow between 2.5% and 4.5% in the first quarter, which compares well to Southwest’s expected 4% to 5% growth. Delta is looking for 0% to 2% growth, while United has said to expect 0% to 3%.

Alaska Air’s RASM is expected to grow between 2% and 2.5% in 2019, mostly due to slower growth in the third and fourth quarters. That’s mostly timed to the airline’s plans to add planes and capacity, and some merger-related issues.

Overall, Alaska Air’s total revenue is expected to rise about 6.4% this year, while analysts are looking for a 50% increase in earnings. The consensus 2019 earnings per share is now $6.64. That outlook is being helped along by Alaska Air’s plan to expand its profit margin from last year’s 9.8% to between 13% and 15% this year. All in all, Alaska Air Group is a great example of a well-run, low-cost airline.

That’s not to say there aren’t any risks. Investors have been worried that the big drop in oil prices since October might encourage airlines to add more seats. Several airlines have cut their RASM forecasts, expecting to do just that. That could lead to stiffening competition on the West Coast, Alaska Air’s largest market, where fares have already been falling.

There’s also a chance that fuel costs could rise. Oil is cheap right now, but Saudi Arabia has cut oil production and OPEC is targeting $80 per barrel this year. I doubt oil prices will get that high but, barring a recession, I wouldn’t be surprised to see oil get back into the high $60s this year.

Higher fuel costs and increasing competition could both be a drag on profits. Still, Alaska Air has coped with both of those before, so I wouldn’t expect it to be catastrophic. That’s especially true since it expects to realize about $130 million in “merger synergies” this year and expects another $240 million benefit from its other revenue initiatives.

Another big benefit for investors is that Alaska Air is undervalued relative to other airlines. The stock is trading at just 0.93 times sales, compared to the industry average of 1.98 times sales. It’s also trading at 6.4 times cash flow, half the industry average. So, as investors realize how well Alaska Air has been performing, it’s likely we’ll see its valuation rise.

If the earnings forecast proves correct, and the airline’s valuation moves closer to the industry average, that could make Alaska Air an $80 stock in a year or so. While we wait, I look for the airline to continue buying back its shares and maybe even increasing its dividend again later this year or early next year.

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