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Airlines are back. Low oil prices and holiday travel should keep them up in the air.
Airline stocks used to be one sector I would never touch as an investment.
Debt was crushing them. They were poorly run. They were too vulnerable to system disruptions. There was no brand loyalty.
However, they have now all either merged or gone bankrupt, and are doing very well amidst a travel boom. Regardless of the overall weakness in the economy, the travel sector continues to do well and so have the airline stocks. Here are three I would look at, including one name you probably wouldn’t expect.
The obvious choice is the one I’ve always “luved,” Southwest Airlines (NYSE: LUV). The airline recognized well before anyone else that an airplane is really just a flying bus. Drive it in, clean it out, push off again. The turnaround time became the envy of the industry, and now all competitors try to emulate it.
Southwest remains extraordinarily well-managed. It was the only airline still profitable in the years after 9/11. It remains the winner in customer satisfaction most every year. Its short-haul strategy has paid off so well that they have gingerly and modestly expanded into longer-haul flights, including a recent move into international travel.
Its balance sheet is the best in the industry, with $3.6 billion in cash and only $2.1 billion in debt. That’s right: Southwest could use cash on hand to pay off all its debt if it wanted to. Its free cash flow was $1 billion in FY13 and $1.2 billion over the past 12 months. A solvent airline! It also pays a dividend.
Although more expensive than its peers at $40 per share and an Enterprise Value-to-EBITDA ratio of 8.6, it remains the best stock in the sector.
The next airline stock is Virgin America (NYSE: VA), a company that recently went public.
If you’ve ever flown Virgin, then you know its has managed to make its flying experience stand out from all others. It’s almost…fun. It has a signature style. It receives great reviews from its users. And it has limited itself to specific airports and routes that are profitable.
In its Q3 earnings report, which came out a few days before the IPO, Virgin reported some very nice results: $52.3 million in operating income (up 18% YOY), $41.6 million in net income (up 24% YOY), with a 12.9% operating margin. Total revenue was up 4.7% to $405 million.
Year-to-date, Virgin’s net income is now $56 million, up from a $4 million loss through three quarters a year ago. The airline also has $184 million in cash. One word of caution: despite the strong year, Virgin says its profits have been up and down in recent years.
My take here is that Virgin is a great product, and it has either turned the corner or will run back into losses. This one is for speculators, and there may be tremendous upside if VA delivers.
My last choice is Copa Holdings SA (NYSE: CPA), an airline based in Colombia. It’s actually known as the “Ryanair of Colombia.”
Now that the drug cartels have been chased off, Colombia is about to explode as a major tourist destination. I have friends who are setting up businesses there and report back on five-star resorts being filled to capacity, marinas popping up everywhere, and international companies starting to expand into the country.
Copa may just become the Southwest Airlines of the region. It has a great balance sheet with $1.1 billion in cash and $913 million in debt. It has amazing free cash flow, to the tune of $730 million in FY13. I suspect, however, that the free cash flow is going to decline as the airline updates its fleet.
Nevertheless, Copa is a hugely profitable airline with $427 million in net income in FY13. It’s a great play for those banking on Latin America growth, particularly in Colombia, over the next decade.
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