ALGT came up again in the 2011 Forbes Best Small Company list so it was time to give it a chance. After all, I can’t always spoil myself by studying companies that always meet my criteria. That would only limit my investment view and learning curve. As I wrote previously, studying bad companies is good for you.
Upon reading ALGT’s company reports, I found it very educational and highly entertaining.
I definitely recommend you to read the annual report to get a bigger picture of the airline industry and especially ALGT.
Allegiant Travel Company (ALGT) Analysis
ALGT Business Description
From the 10-K:
Operates a low-cost passenger airline marketed to leisure travelers in small cities, allowing us to sell air travel both on a stand-alone basis and bundled with hotel rooms, rental cars and other travel related services.
- Paid one time dividend in 2010 of $0.75 per share. Always a good sign when management is willing to distribute one time dividends.
- 2010 executive compensation was 0.6% of 2010 revenue
- Strong insider ownership of 22.3%
- Recent big sales on the open market by President
- CEO background is an investor and entrepreneur. He was one of the founders of ValueJet. Also founded MPower Communications. Got to have good business sense and vision to successfully create companies.
Strategic Advantage/MoatThe airline industry is highly competitive yet ALGT has many advantages over its bigger and smaller competitors. In most businesses, efficiency comes from scaling operations, but not in the airline industry.
ALGT proves this in the way it does business.
They have less planes, less flights and less routes, yet are better off than most of their competitors who continue to lose money year after year.
Here is how they do it.
- Low cost operator. In a capital intensive commodity business, having a low cost business model is utmost important.
- Focuses on the leisure traveler instead of business travelers. Leisure travelers want cheapest airfares first and schedule their trip around their flight itinerary. Business travelers place great importance on their own business schedule with price coming second. This strategy allows ALGT to provide low frequency services from small cities but makes full use of capacity.
- Every flight is a direct flight. No connecting flights.
- Uses larger jet aircraft to provide nonstop service from small cities direct to leisure destinations.
- Does not use frequent flyer programs or code-share arrangements. Only worthwhile for heavy travelers who use the same airline to accrue points. Doesn’t suit the leisure traveler who wants the cheapest flight.
- Sells directly to travelers without participation in global distribution systems. This means ALGT does not sell tickets through Expedia, Travelocity or any other travel website. Tickets can only be purchased via their website, over the phone or at a ticket counter. This equates to less expenses.
- Has a variable flight schedule. Depending on demand and profitability, ALGT will cut or add flight routes. One example is how they moved back to Orlando Sanford International airport from Orlando International Airport as there wasn’t enough profit from operating in Orlando International Airport.
- The variable flight model also allowed ALGT to cut flights by half when oil prices skyrocketed in 2008 and the recession hit later on. They can easily ramp up the flights when oil prices are low or when holiday season begins as well.
- The entire goal for a flight is to fly full, yet most airlines can’t achieve this. ALGT temporarily suspends flying to some holiday destinations during non peak periods when demand is down.
- Focuses on markets where competitors will find it difficult to enter. The bigger airlines will have to accept losing money in these markets if they want to compete for market share.
- Sells holiday packages in additional to tickets. Contracts with hotels and resorts to provide holiday package deals to customers.
- ALGT also makes good revenue from optional fees. The fees listed below was from a review of ALGT found online. Link is available at the bottom.
- Premium seat selection: $9.99 – you get an assigned seat near the front or at the exit rows.
- Standard seat assignment: $6.99 – gives you an assigned seat towards the back of the aircraft.
- Online checked bag fee: $39.98 – might be more than the industry average, but you want to pay it online, since it will cost you $70.00 per bag at the airport.
- Makes use of strategically located bases to shift schedules and flights, perform line maintenance, overnight parking of aircraft, and other operations support.
- Does not hedge fuel costs
GrowthThe main growth driver comes from ALGT’s ability to expand into more smaller cities. There are hundreds of smaller cities located hours away from international airports, and people living in these areas also have to fly somehow.
Since ALGT purchases used MD-80 airplanes on the cheap, it will be able to penetrate these locations as their cost to open a new route is much cheaper than a bigger airline.
Growth also comes from ancillary revenue. By making better deals with resorts, hotels and casinos, ALGT is able to generate more commission from its package sales.
ALGT is working on a direct flight to Hawaii which should add growth.
- Of the 161 routes it flies (according to last 10-K), only 10 routes have competition.
- Due to its profitability, ALGT trades at a premium to its peers.
- Gross margin is around 40%. Unheard of. Comps are around 15-18%.
- MD-80 airplane engines no longer being made could lead to parts shortage.
- Having to replace their current fleet of MD-80’s. Different planes mean new maintenance, training, schedules, parts etc
- MD-80 planes are also about 20 years old which is a risk. This has been discussed in the forum so I’ll leave out full details today.
- Increased industry regulation resulting in higher fees and licenses.
- Bigger competitor willing to lose money to take market share from ALGT.
- Another recession or terrorist activity causing a big decline in flights.
- On Feb 1, ALGT announced their 36th consecutive profitable quarter
- Passenger revenue per available seat mile (PRASM), perhaps the most important bottom-line measure of an airline’s health, increased 11.7% over the year-ago period and 19.2% for all of 2011.
- $320M in cash and only $146M in debt
- I’ll leave valuation out this time around as I am not comfortable valuing airlines.
- Reconfiguring fleet of MD-80 aircrafts from 150 seats to 166 seats. The increase in seats per plane directly increases revenue potential.
- New flight routes to Hawaii will meet the popularity of Hawaii vacations.
- New and additional ancillary third party products. Create better holiday packages to drive additional revenue.
ConclusionWhile learning about the company, I couldn’t help but be impressed by the business strategy and business savvy. Maybe it is because the CEO is an entrepreneur at heart.
Previously, I had never thought about airlines as a potential investment opportunity but ALGT completely shatters that assumption.
At the current price, it is clearly at a premium, but if it comes down to a reasonable range, ALGT is definitely one to watch out for. As the spider graph shows at the top, ALGT is a well rounded company.
- Allegiant company presentation http://bit.ly/yBxA1N