Is There Upside For Alaska Air Group Stock At $37?

After gaining 54% since the lows observed on March 23, we believe that Alaska Airlines’ stock (NYSE: ALK) has a potential upside at the current price of $37 per share despite tepid air travel demand and growing long-term liabilities. The coronavirus crisis brought air traffic to a grinding halt and prompted regulators to provide a $25 billion bailout to the vulnerable industry. Interestingly, smaller fleet operators, including Alaska Airways, are in a better position primarily supported by a higher operating margin and younger fleet. The company has roughly 100 unencumbered aircraft with an average age of 9 years, real estate assets, slot assets, and a loyalty program. In comparison, the average age of American Airlines and Delta Airlines’ mainline fleet is 11 years and 15 years, respectively. While American and Delta’s unencumbered assets are worth nearly 4x that of Alaska Air Group (ALK’s fleet size = 300 aircraft; DAL fleet size = 1062) but, after United Airlines failed bond offering which was secured by older aircraft, the unencumbered assets of larger carriers are attracting higher interest rates due to limited service life.

After the CDC’s travel advisory in March, domestic and international air travel demand plummeted by more than 90%. Currently, passenger numbers at TSA checkpoints are down by almost 70% (y-o-y). While the company’s revenues and earnings have consistently grown over the last couple of years, the $120 million of monthly cash burn has put pressure on the company’s management to raise additional debt capital. Despite the soaring interest burden eroding shareholder value, we expect the company’s higher share of unencumbered assets to support future debt offerings. Also, the stock is currently trading at a trailing P/E multiple of 5.8, nearly 50% lower than 2019. Our dashboard Why Alaska Airways Stock moved -48% highlights the key numbers, and we explain more below.

Alaska Airlines’ Revenues have grown by 11% from $7.9 billion in 2017 to $8.8 billion in 2019, which has translated into a lower net income expansion due to a percentage-point reduction in adjusted net income margin. Moreover, the earnings growth on a per-share basis has also remained similar due to relatively flat shares outstanding. In the past three years, the company has spent more capital on retiring debt instead of repurchasing shares. Due to the growing debt burden and ongoing cash preservation measures, we believe that the company will keep dividends and share buy-backs suspended until the air travel demand recovers completely. But given the company’s younger fleet, a large pool of unencumbered assets, and substantially low P/E multiple, we expect an upside in Alaska Airlines’ stock.

Can Alaska Air Group’s Liquid Assets Support Its Cash Burn Rate?

The U.S. Airline industry received a $25 billion bailout under the CARES Act to support employee costs for the second and third quarters. As employee and fuel expenses account for nearly 50% of the total operating expenses, the company requires additional funds to support these huge expense heads after the CARES Act grant runs out. Other carriers, including Southwest, Delta, and JetBlue have also been raising debt capital to cover fixed costs in the fourth quarter. Alaska Air Group raised $1.2 billion keeping 61 aircraft as collateral in Q2 and reduced the cash burn rate from $400 million per month in March to $120 million in June by curtailing capacity and reducing overheads. Currently, it has sufficient cash to support fixed costs if air traffic demand recovers by year-end or early next year. Also, another $25 billion in aid by the U.S. government will preserve investor wealth and safeguard jobs for a couple of quarters if the coronavirus crisis shows no sign of abatement.

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