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Alaska Air Group (ALK) - Ikarus Rising

March 10, 2013 | About:
gmax

gmax

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The transportation airline industry group posted the largest gains in the past eight weeks with Alaska Air Group (ALK) up 29%, being one of the top advances next to Sprint Airlines (SAVE), up 31%.

ALK’s last results show a 5% increase in traffic on a 4.8% increase in capacity year-over-year in February 2012.

On a 5-year horizon, revenues have been rising steadily except for a bump in 2009 to a historic high of $4 .6 billion in 2012 (+ 7.8%) and EPS of $4.4 (+ 31.7%) versus the previous year.

A comparison of the latest Q4 2012 sales reveals a 8.4 % increase and a surprising 31% drop of EPS versus the. previous year.

For almost 27 years the median value of the stock had been only about $10.

From June 2009 until January 2012,it rallied from $9.1 to a new peak at $38.1, reaching (+284%) before plateauing around $35 for six months.

From August 2012 at $33.5, it resumed its upward surge to an all-time historical high of $57.5 (and counting?!) as of March 08.2013, i.e another 72% jump in about seven months.

Altogether the stock has rallied by over 530% as of now and might move even higher still given its strong upside momentum and new daily record highs.

The large majority of analysts have a strong buy and buy ratings and a consensus target price of $60.

The overall sentiment on the stock is decidedly bullish and the surge can be put down to momentum traders intoxicated by the increasing feel-good factor created by the DOW and S&P hitting ever new record highs on a daily basis.

The upward move of the airline industry in general and ALK in particular - the rationale goes - is the result of a strengthening economy and thus increasingly good outlook for ALK and its portfolio of destinations …or so they think.

Against the backdrop of this overall great and promising news and expectation, one should take a note of net (sells minus buys ) insider sales of about 400 000 shares during the past 12 months.

In addition to that the short interest has risen almost fourfold during the past 11 months.

For a reality check and perspective, investors should ask themselves the following questions:

1. Where will future additional business growth (after Hawaii) actually come from when considering organic growth only?

2. Airlines are a cyclical business and as such move in tandem with the economic cycles without exception, do they not?

3. During the almost three decades preceding the described rally, real economic and real business boom times almost never catapulted the stock too high above its long-term median price of $10. Does the mere hope for and projection of an improved economy justify the extreme surge and sky-high stock price?

4. Why is it that insiders are busy selling their own stock when so much more good news is supposedly in the cards?

Bottom line: While the financials of the company have proven sound, the continued rise of its stock price to all-time historical high levels is out of sync cannot be justified.

The potential for organic business growth for airlines in general and for ALK in particular is limited and as such not much additional and significant sales upside is warranted at this stage.

The rationale for the rally, being the improved economy and outlook, simply does not hold up to scrutiny and the lessons of history.

Case in point: Much revered Southwest Airlines (LUV), formerly run by legendary founder Herb Kelleher (once named best CEO in America ), continues to thrive boasting great financials.

However in spite of all this and the “ improving outlook” it has never managed to regain its former all-time high of $22.3 and currently trades well below around only $12.

A continuation of this exponential upward thrust – while possible in the very short run only - is simply unsustainable in the long run and can and shall not last.

What the mad crowd of momentum investors getting in at the very top constantly seem to forget is the fact that the risk (high & increasing) reward ( low & diminishing) relationship is strongly inverse at these levels. They are willing to bet on only marginal and limited upside potential while completely ignoring the significant above average downside risk inherent in such high-flying stocks.

Remember the old stock market adage:

“Wall Street forgets everything and learns nothing!”

The air is definitely getting thinner for ALK. It is in my view in the very final stage of an unwarranted upsurge before the overdue empiric inflection point!

The closer Ikarus is getting to the sun, the sooner the wax holding together his wings will melt and cause an epic fall down to earth and much more reasonable levels that characterize all cyclical stocks.

Disclosure: I am short ALK.

Rating: 3.6/5 (7 votes)

Comments

teidelman
Teidelman premium member - 1 year ago
I met Alaska Airlines management a few months ago and was really impressed with them, the company, and the stock as a long investment. They are laser focused on doing all the little things right to be the best (on time performance, incentives for employees, competing in markets that they dominate and have pricing power, etc). I had similar doubts despite their ability to earn a very high ROIC around 14% for the last three years and wondered if they could keep it up. I’m convinced they will not only keep it up, but improve on it. I highly recommend reading the recent New York times article to get a flavor for their culture http://www.nytimes.com/2013/03/03/business/alaska-airlines-flying-above-an-industrys-troubles.html?pagewanted=all&_r=0 , but we also had an employee who was an air force pilot and said all his friends top choice employer was Alaska airlines and there is a reason for it. They treat and pay their employees really well. They have incentive comp for everyone and an extra $100 month if they hit targets for everyone.

The last few years improvement was indeed heavily due to picking up routes to Hawaii because of bankruptcies of companies like ATA, etc. They have a high performance culture and I think it will stick. With the best balance sheet and lowest cost structure, I think it is not just a great airline, but a great company. Analysts estimate EPS of 5.50 and 6.20 for the next few years. My purchase price is $45; however even at $57, the stock trades at about 10x ’13 EPS for a great company. While pricey compared to airlines (most of which have huge pension obligation and negative networths), it is undervalued relative to their market as a whole. I think ALK will continue to execute well and the stock will move up commensurate with earnings and may even experience multiple expansion as people believe their earnings are here to stay. I’m betting on it. I also warn against shorting “great” companies because you think they are too high.

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