Among companies trading on the New York Stock Exchange and the Nasdaq, airlines have high growth and value potential. Alaska Air Group Inc. (ALK, Financial) and Allegiant Travel Co. (ALGT, Financial) currently have low cash conversion cycles, which lead to effective management and increasing profit margins.
Cash conversion cycle measures efficiency and management effectiveness
As discussed in previous articles, companies with increasing days inventory (DI) and days sales outstanding (DSO) are likely inefficient, usually resulting in poor financial strength. On the other hand, companies with decreasing DI and DSO have more efficient business operations. The cash conversion cycle (CCC) can summarize a company’s days ratios using one single value: the sum of DI and DSO minus the days accounts payable (DAP). Lower CCC implies higher efficiency and management effectiveness.
The distribution of average cash conversion cycles across industries is slightly left skewed with a median near 51 and a standard deviation of 39.11. Likewise, the distribution of median cash conversion cycles is centered near 41 with a standard deviation of 37.72. Only four industries have an average CCC greater than 150.
To determine the best industries to invest in based on cash conversion cycles and days ratios, we can rank the industries using the following guidelines:
- Assign 2 points for “Good DI” if the average days inventory is less than the average historical median DI.
- For both the average DSO and median DSO, assign 2 points for “Good DSO” if the current value is less than the historical median value.
- If the current value is lower than the historical median value, assign 3 points and 1 point, respectively, for “Good Average CCC” and “Good Median CCC.”
- To get the industry’s investing score, simply take the sum of the above scores.
Forty-one industries, including the airline industry, have an investing score of at least 6, including 18 with investing scores of at least 8.
Low CCCs lead to high profitability
Both Alaska Air and Allegiant Travel have a profitability rank of 9, suggesting high growth potential. The companies have several good investing signs, including expanding operating margins and consistent per-share revenue growth. As of Sept. 28, Allegiant Travel’s operating margin outperforms 96% of global airlines while Alaska Air’s operating margin outperforms 94%.
Even though the companies had increasing cash conversion cycles during the past five years, the companies have single-digit CCCs as of June 2016. Allegiant Travel’s CCC is 9.6 while Alaska Air’s CCC is 8.76. This suggests high efficiency and management effectiveness, likely reasons for the expanding operating margins and consistent revenue growth as discussed above.
As these companies have high value potential, several gurus have invested in Allegiant and Alaska Air during the second quarter. Joel Greenblatt (Trades, Portfolio) and Paul Tudor Jones (Trades, Portfolio) purchased 18,441 and 1,423 shares of Allegiant, respectively. The leisure travel company averaged $154.33 per share.
Likewise, Jeremy Grantham (Trades, Portfolio) and Greenblatt purchased 509,978 and 540,327 shares of Alaska Air, respectively. The Alaska based airline averaged $69.08 per share. With his investment in Alaska Air, Greenblatt nearly raised his stake ninefold.
See also
Allegiant Travel and Alaska Air also have strong Piotroski F-scores, with the latter having the maximum F-score of 9. Based on backtesting results, the Piotroski investing strategy generated an overall return of over 300% with annual rebalancing. The “Low CCC, High Margin Growth” investing strategy also had strong overall returns relative to the Standard & Poor’s 500 index exchanged-traded fund, as displayed in the following table.
| Year | SP 500 ETF | 5 stocks | 10 stocks | 20 stocks | 30 stocks | 40 stocks | 50 stocks |
| 2006 | 13.74% | -2.38% | 39.49% | 16.77% | 23.76% | 23.76% | 23.76% |
| 2007 | 3.24% | 36.02% | 16.95% | 12.13% | 8.54% | 12.16% | 13.63% |
| 2008 | -38.28% | -52.53% | -52.04% | -49.76% | -46.41% | -37.34% | -37.58% |
| 2009 | 23.49% | 51.25% | 49.05% | 41.92% | 37.24% | 38.89% | 36.39% |
| 2010 | 12.84% | 12.83% | 32.34% | 18.70% | 46.05% | 46.05% | 46.05% |
| 2011 | -0.20% | 5.33% | 2.85% | -3.53% | -6.34% | -5.76% | -5.76% |
| 2012 | 13.47% | 22.14% | 17.25% | 6.81% | 12.09% | 9.26% | 9.62% |
| 2013 | 29.69% | 72.20% | 45.91% | 47.06% | 45.99% | 45.99% | 45.99% |
| 2014 | 11.29% | -6.15% | 9.90% | 9.15% | 6.56% | 7.28% | 7.28% |
| 2015 | -0.81% | -25.25% | -11.62% | -8.11% | -13.54% | -6.08% | -6.08% |
| 2016 YTD | 5.84% | 11.20% | 37.42% | 24.53% | 16.31% | 13.59% | 11.74% |
| Overall | 73.30% | 85.89% | 262.36% | 109.73% | 136.93% | 203.48% | 196.84% |
The above table assumes annual rebalancing from January 2006 to January 2016, and ranks the company stocks by increasing cash conversion cycles.
Allegiant Air and 14 other industrial companies made the Undervalued Predictable Screener as of Sept. 28. The top 25 undervalued predictable companies generated a total return of 187.35% during the backtesting period from 2009-2016 based on model portfolio data.
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Disclosure: The author has no position in the stocks mentioned in this article.
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