Can Alaska Air Reach $90?

Alaska Airlines (NYSE:ALK), the fifth largest airline in the United States by fleet and passenger revenue, is currently trading at $62 with a  forward P/E of 9.8. Compared to its peers, Alaska Air has better fundamentals, owing to its low leverage, and its ability to operate efficiently relative to its peers. It has a better return on equity, at 22.5%, and has had relatively steady growth of 5% yoy. With the recent declines in oil prices, and the price of oil being a key component of Alaska Air’s costs, it is surprising that the stock continues to trade at a discount to its peers.

We currently have a price estimate of $70 per share, which is 12% higher than the market price. You can use our interactive dashboard Alaska’s Path To $90 to modify key drivers and visualize the impact on ALK’s price estimate.

Furthermore, the company is not highly levered with the current ratio (0.7) being lower than many of its peers. Debt has been one of the biggest concerns for the airline industry, in an environment where interest rates are going up. This is not the case with Alaska Air. This is especially useful for the company to expand its fleet as aircraft manufacturers bring newer, and more improved aircraft onto the market in the coming years. Furthermore, Alaska’s low leverage, therefore, will aid the aircraft in terms of margins, and the ability to weather higher oil prices relative to its peers.

In addition to everything else,  the recent declines in oil, should result in an improvement in Alaska’s cash flows. Should the stock trade at a valuation similar to those of industry averages, we believe the stock could rise to $90 per share, but before it does so, there are fundamental issues to consider, mainly revenue growth.  That metric has been slow, which may mean the market will continue to undervalue the stock, especially if revenues don’t rise as quickly as those of Alaska’s industry peers.

Further, relative to its peers, Alaska Airlines is expected to see pre-tax margins improve to 15%, with industry peers averaging 11%. Alaska Air also has a higher ROIC (return on invested capital) of 16.7%, vs its industry peers at 13%. Again all of this points to higher relative cash flows, which is fundamental to airlines.

The most important issue facing Alaska Air is growth, the company has been growing at 5%, while many industry peers, have been able to increase revenue yoy at 8-10%. This is seen as a headwind, with Alaska Air not expanding, or taking advantage of increased passenger flow in 2018, unlike many of its peers in the industry. Part of the issue stems from the airline’s merger with Virgin. With logistical issues of the merger weighing on operations, Alaska grew slower than it otherwise would have. But beyond this, there are few issues with the airline, and we therefore believe this is a stock that is flying under the radar, and being ignored by the broader market.

The company, has been improving itself to increase fleet, and routes. These improvements will come to the fore in 2019 as the new routes, and planes become operational. Overall the stock may benefit as tailwinds from lower oil prices, along with factors already mentioned take hold. But with the recent sell-off the stock’s upside is dependent on overall market sentiment, and may reach $90 in over 4-5 quarters should the airline’s earnings continue to show marked improvement.

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