Airline Stocks Flying to New Heights

airline-stocksThe good times continue for the travel and leisure industry – and especially for airline stocks.
For many years, I wouldn’t go near this sector. The airlines were loaded with debt, struggled to generate cash flow and were held hostage by energy prices. All that has changed for several reasons.
Practically every airline has been through bankruptcy and has been able to restructure or eliminate debt. The airlines got smart about cutting expenses and started charging fees for everything under the sun. Dynamic pricing models developed, allowing airlines to maximize revenue. Much to the consternation of frequent flyers, airlines have devalued their loyalty programs to avoid giving away too much revenue.
This is all reflected in quarterly earnings. Let’s take a look at how Alaska Air Group (NYSE: ALK) and Southwest Airlines (NYSE: LUV) fared this quarter.
For Alaska Air, adjusted earnings of $1.12 per share soared to new heights, rising 75% year-over-year. This great result can’t solely be explained by the 33% decline in fuel costs, for despite a struggling economy, travel demand has been high for some time.
The EPS growth came on a 4% revenue increase (to $1.27 billion), as well as a 5.3% decline in operating expenses.
Let me point out how important it is for an airline when it can boost revenues and cut operating expenses. Airlines can’t really be valued on a traditional price-earnings ratio basis, because they are sensitive to so many variables. Instead, I value them on an enterprise value to cash flow basis.
Cash flow is what makes an airline live or die. That’s because it is a highly capital intensive business, requiring a lot of cash flow to keep it going and to pay its debt service.
Airline traffic, which is measured in “revenue passenger miles,” or RPM, reflected this demand. RPM was up 9.1%. The related metric of passenger revenue per available seat mile (PRASM) decreased 5.7%. That means that Alaska Air may have had to deal with competition in its market, and lowered prices in order to boost the number of passengers it carried.
Alaska Air’s balance sheet is in great shape. It’s one of the few airlines with more cash than debt, at $1.31 billion of cash versus only $650 million in debt.
It’s hard to believe, but that means Alaska Air was able to spend about $100 million buying back stock. It also boosted its dividend to $0.20 per share, up 60% over last year.
Over at Southwest, EPS came in at 66 cents a share, on a 6% revenue increase. Southwest also delivers freight, and that segment saw a 10% revenue increase.
Southwest’s traffic and revenue stats were similar to Alaska Air’s, but actually came in stronger. RPM increased 7.1%, but PRASM increased 0.3% year-over-year versus Alaska’s 5.7% decline. That shows that Southwest retains pricing power in its markets.
Adjusted operating income went crazy, nearly tripling from $242 million to $770 million. Meanwhile, adjusted operating expenses fell 7.1%, so both airlines are enjoying good cash flow. Southwest generated $1.45 billion of cash flow in the quarter.
Sure enough, Southwest is one of the privileged few with a great balance sheet, holding $3.44 billion in cash against $2.42 billion in debt.
Both airline stocks have been soaring the past few years. Is it too late to buy in?
On our EV-to-EBITDA (enterprise value to earnings before interest, taxes, depreciation and amortization) valuation metric, we see Southwest at 9.16, while Alaska Air is at 6.69.
Given Southwest’s higher valuation, I think Alaska Air is the buy here.
DISCLOSURE: Lawrence Meyers currently owns shares of Southwest Airlines.

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