Many investors stay away from airlines as a matter of course: Airlines suffer from cutthroat competition, price-sensitive consumers, little brand loyalty, and expensive costs like planes and fuel. However, I think this aversion has left undervalued several quality companies that can gain market share and deliver solid returns going forward. HoTo find these gems, I’ll analyze the industry using Stock Rover.
One of my favorite Stock Rover features is the ability compare tickers by industry deciles. This is an especially useful tool in the hypercompetitive airline industry, and will help us find the companies best positioned to take advantage of expected growth. First, let’s rank by Price/Earnings, a common metric to see if a stock is undervalued. I’ll include all tickers in the top three deciles.
There are some promising candidates here, but also some lemons. American Airlines (AAL) looks great in P/E and Profitability relative to the industry, but their balance sheet is a complete disaster. Their Debt/Equity ratio is an abysmal 6.9, and their current liabilities exceed their cash on hand. United (UAL), also a top finisher in P/E, faces similar trouble: D/E ratio of 4.1, not enough cash on hand to cover current liabilities, and $32.47 in debt per share. Theoretically, investors could buy now, let the airlines clean their balance sheets, and then enjoy higher share prices and stronger profits, but I’m not convinced this will happen any time soon. These airlines are cheap for a reason.
Japan Airlines (JAPSY) and Aegean Airlines (AGZNF) both perform well in many of our rankings, but economic conditions in their respective countries make them riskier bets. A depreciating yen in Japan and a possible Greek exit from the Euro could cut into earnings for foreign investors. Not even a flotation device under their seat could save investors then.
Let’s rank again by Return On Assets (ROA) versus the industry, a useful way to see how efficiently an airline is using their existing fleet. I’ll include only tickers with a positive result.
The top of this chart is pretty impressive. Spirit (SAVE) and Mexican carrier Volaris (VLRS) both have about triple the ROA of some companies in the middle of our table. To see if we have some real winners here, let’s take a deeper look at those two stocks, as well as Alaska Air Group (ALK) , Southwest (LUV), and JetBlue (JBLU), which all perform well in a number of our indicators.
Let’s start with Volaris, the smallest airline in our group, with a market cap of $1.2 billion. However, they appear to be pretty safe for a small cap, given the health of their balance sheet, which contains very little debt. According to their CEO,  Enrique Beltranena, Volaris is planning capacity increases of about 5% on domestic traffic and 31% on international traffic this year and next, and has also hedged fuel costs for the rest of this year. Given that Volaris is already the second-largest Mexican carrier, I would classify this as a relatively safe small cap stock. Their clean balance sheet and disciplined growth should help them gain market share in North/Central America while delivering robust returns.
As shown in the above table, Volaris’ other financials are a mixed bag, relative to our group. First, Volaris’ EBITDA margin is the worst of our group, and their P/E is 15.1. However, their margins and return on capital are consistently improving, and pretty handily at that. Investors should also note that the company has no plans to institute a dividend any time soon, and will instead reinvest the capital in their business, according to their CEO .
Spirit comes out near the top of our industry rankings on profitability, financial health, and growth. What’s behind that showing? Spirit’s margins have increased in each of the past four years, and it boasts the highest net margin and return on assets in the industry. Their balance sheet is the best of our group, with plenty of assets on hand to cover debts. They also lead our group in expected EPS growth for next year, and their fleet and network are growing.
While the stock clearly provides plenty of growth potential, investors have already taken notice. Spirit’s 17.8 PE is the highest in our group, However, that’s still below the S&P500 average P/E of 21, and Spirit’s stock comes with strong growth numbers. The company also does not offer a dividend, unlike Southwest or Alaska.
Alaska Air Group
Alaska presents intriguing prospects for value and dividend growth. ALK leads our group in both EV/EBITDA at 5.8 and in P/E, thanks largely to a group-pacing $4.92 EPS. That is expected to jump even further as management continues to buy back shares. Their dividend, already at $0.80 a share for a yield of 1.2 percent, has room to grow: ALK’s payout rate stands at only 11 percent. Alaska’s margins and returns on capital have also been trending steadily upward, and sales are expected to grow about 4 percent this year. They have labor contracts signed  through the next four years, which may give them a cost advantage versus competitors. The company’s balance sheet shouldn’t get in the way of future returns.
Alaska may also benefit from positive consumer attitudes. According to J.D. Power and Associates, Alaska leads the traditional carrier market in consumer satisfaction, earning, a 737 score on a 1000 point scale, substantially higher than the next highest traditional carrier, Delta, which gets a 693.
Management’s strategy seems to be  focused on maintaining the dividend, while buying back shares as income comes in, rather than borrowing. Ultimately, a bet on Alaska is a bet on a solid management team that has been making a real effort on behalf of investors.
I think Southwest has a lot of quantitative and qualitative factors going for it. America’s fourth-largest airline has increased its margin and return on capital in each of the past three years. Dividends, now $0.30 a share, have grown 95% in the same timeframe, and Southwest’s payout ratio of 11.4 percent leaves room for further growth. EPS growth has been boosted by a share buyback program that is expected to continue into next year, and revenue growth should be in the 5-6 percent range both this and next year. While the balance sheet has some weak spots like cash on hand, the company has less debt per share than any airline in our group except VLRS, and plenty of access to credit . The company also has a strong history of positive performance.
To their credit, Southwest successfully incorporated its acquisition of AirTran into its operations, and is cutting its costs across a range of activities. This is especially impressive given how poorly other airline mergers have gone: I’m looking at you, United Continental . Further, Southwest is currently expanding in major metropolitan markets, notably Washington, D.C. and New York, while trimming some of its smaller, underperforming routes. They also have plenty of room to expand into international flights, which they are doing at a “measured pace,” according to CEO Gary Kelly.
The qualitative positives includes both a solid business culture and a strong market position. Southwest has a long-running profit-sharing plan and a mostly unionized work force, which may drive away some investors, but might also result in a higher service quality. Southwest boasts high consumer satisfaction, coming a narrow second to JetBlue in the low-cost carrier segment, according to J.D. Power. They also have by far the most generous baggage policy in the industry. I would think that consumer sentiment could make a difference for airlines—i.e. which ticket do you buy if cost and scheduled time are pretty similar, especially on longer flights? I think this is where consumer satisfaction materially benefits Southwest.
Like the other stocks in our group, JetBlue is expected to continue its trend of outperforming the industry. JetBlue’s margins, revenue, and return on capital have all consistently increased over the past few years, jumping especially from 2013-2014. EPS growth too has been very strong since 2013, though investors should be wary of share dilution, which is sapping about $0.20 per share from earnings. Their balance sheet, while not a major concern, could use some cleaning. JetBlue has been and will continue to expand their fleet, which has left $1.9 billion in debt on their books.
JetBlue’s share price has about doubled in the past year, though P/E is still good at 12.6. JetBlue’s growth should be helped by consumer satisfaction: the company leads the low-cost carrier segment, according to J.D. Power, scoring a 789, almost 40 points higher than the segment average 763. JetBlue also boasts Mint, a premium ticket that buys you a fully-reclinable seat, one of few carriers to do so.
The screens in the seatbacks, a nice feature of JetBlue’s A320s, will get larger with long-term renovations. Those renovations will also increase revenue by skimping on leg room and charging for bags, which may turn off some customers. Overall, this change in direction appears to be part of a leadership change. In sum, I think JetBlue has great upside potential, though is a higher risk than some of the others in our group due to its balance sheet.
All of the five airlines in our group could make a nice addition in a long-term portfolio. Volaris presents a relatively safe small cap stock with potential for long-term growth. JetBlue doesn’t have the greatest balance sheet, but could make up for it with robust returns. Spirit has the highest P/E of our group, but also the strongest growth prospects. Alaska Air Group and Southwest both present intriguing opportunities to bet on strong management, with likely continued profitability, at least into the next year.