- Fabulous management team with great track record.
- Customer service centric approach has led to fantastic growth and loyalty.
- Sound growth strategy that has been proven over the past 12 years.
- Effective cost control and clear targets for fuel cost mitigation.
- Improving debt profile with sound fundamentals.
Alaska Air Group is a quality airline with a great track record of growing its fleet, routes and average seat miles (ASMs) while effectively controlling its costs and managing debt. The management team has proven itself to be extremely capable and while oil prices stay anywhere close to their 5 year low, this is probably the best airline money can buy.
Alaska Air Group, Inc., through its subsidiaries, provides passengers and cargo air transportation services primarily in the United States. The company operates through Alaska Mainline and Alaska Regional segments. It serves approximately 100 cities in Alaska, the Lower 48, Hawaii, Canada, and Mexico. As of December 31, 2015, the company's fleet will consist of 147 Boeing 737 jet aircraft; 52 Bombardier Q400 turboprop aircraft and 13 other aircraft. The company was founded in 1932 and is based in Seattle, Washington.
Thesis & Catalyst For Alaska Air Group, Inc. (NYSE:ALK)
While ALK is trading at all-time highs, we believe there is still significant room for growth in the airline. To date, management has demonstrated a clear focus on quality and growth that has resulted in some tremendous results so far and should continue well into the future. First, their internal staffing measures result in a highly engaged, productive and motivated workforce.
In an industry where service levels are often very poor, this airline has driven staff through clear, achievable incentive programs that ultimately benefit the customer. On the growth front, they have focused on a three-prong strategy of fleet, network (including partners) and routes. This has resulted in CAGR of over 7% for the last 12 years. As the age-old adage goes, the proof is in the pudding - and being ranked #1 in North American customer satisfaction for 7 years running by J.D. Power is definitely a demonstration of these key strategic elements being implemented effectively.
One thing I really like about this group is their focus on simplicity. This is especially clear when you look at their fleet. Over two-thirds of the fleet are Boeing 737s, and 95% of the fleet are just two aircraft. They are currently adding a third aircraft to the mix, but my point remains - when looking to service and manage a fleet of expensive aircraft, the more disparate providers and models you have, the more difficult it is to maintain. I think this has really helped to keep the cost of average seat miles (CASMs) down through the impressive growth that they've achieved.
While I touched on growth above, I believe that we need to look a little deeper at the growth strategy and see why it has worked so well - and will continue to do so with the exceptional execution ability the management team has shown. We touched on the fleet and route growth above, but it's key to understand the actual impact this is having. This year, the business is on target to grow ASMs by 10.5% through these initiatives. This is massive, especially of you consider their historic CAGR has only been around 7%, this is actually one of the largest growth years in ASMs that the business will have experienced - and well ahead of the competitive capacity growth rates that are forecast to be around 7%.
Cost control is key in any airline, but especially key when you're growing at this sort of rate. What is fascinating to see with ALK is that they are forecast for CASMs (excluding fuel) to decrease 0.6% this year. Debt management has also been handled extremely well and overall debt has decrease 13.6% so far this year while growing the fleet as above - decreasing annual interest obligations at the same time as boosting shareholder equity.
Fuel is where the big question mark comes into the thesis. Oil is at rock-bottom prices and, while it looks set to stay there for a while, we can't base our entire investment on unpredictable fuel prices. The team at ALK seems to have this covered off quite nicely too. A mixture of fleet fuel efficiency targeting an industry-leading 85 ASMs/gallon and call option coverage hedging against any spikes in the coming 2 years will both help to offset any potential price increases. The fuel efficiency targets will cover an 11% increase in fuel costs - which is quite sizeable. Ultimately though, fuel cost is and will remain the biggest unknown in this thesis.
Fundamentals and Timing
Fundamentally, this is a very well run airline. Looking at long-term solvency, total debt-to-equity has plummeted from 113% in 2011 to just 30% this year. Their debt is predominantly fixed-rate and they have EBIT to interest expense coverage of 96x. Short-term liquidity is good too with their current ratio and quick ratio very healthy at 0.93 and 0.79 respectively. Returns are consistently high with ROE sitting at 35% and ROACE at 27%. This is quite incredible for an airline. Coupled with a 18.6% ROIC, the ultimate result is net income margin of 14.56%. As an airline with 85 unencumbered aircraft, their true book value is also vary health and price / tangible book is 4.46x. They pay a small dividend that is very affordable, but at ~1%, is nothing to write home about. So far, their earnings have proven very predictable and we feel this will continue into the future.
Timing wise, the share has performed well this year and has good momentum. We see this continuing in the near to mid term.
Ultimately, this is still very dependent on fuel costs, however there are several compelling reasons to believe this business will continue to grow the top line effectively while keeping a tight lid on costs while growing it's fleet and controlling debt. As such, we would target entry around the $77 and look at a long term fair value of between $95 and $105.
Interested in reading more of these fundamental analyses? Click here