In early June, the Peter Lynch screen featured two airline companies, Allegiant Travel Co. (ALGT, Financial) and Southwest Airlines Co. (LUV, Financial), as two of the most undervalued companies based on their earnings lines. Due to potential upside in the airline industry, many gurus are increasing their positions in airline stocks.
Peter Lynch and his winning strategy
A successful investor during the 1980s, Peter Lynch managed the Fidelity Magellan Fund that made an average return of 29% in a 13-year period. According to the June 2015 webinar on investing the Peter Lynch way, the growth-investor devised a strategy for six different stock categories. To determine which stocks are undervalued, Peter Lynch introduced the “earnings line,” a line depicting the expected price of a stock based on a P/E ratio of 15.
Based on its Peter Lynch chart, Allegiant Travel’s stock price sharply declined during the second half of 2015 and dropped below its earnings line near the end of 2015. This suggests that Allegiant Travel is currently undervalued and is a good company in which to invest, according to Peter Lynch’s strategy.
The Peter Lynch screen (feature announcement) implements the investor’s winning strategy by listing the stocks that are undervalued based on their P/E ratios. The Default View lists the earnings yield, ROC, five-year and 10-year EBITDA growth rates, P/E and yield. One of the most useful views is the Charts Views: this view allows users to view the Peter Lynch charts for each of the stocks listed on the screener. Additionally, users can also look at charts showing median P/E, historical P/E ratios and other valuation ratios.
Airline industry among undervalued industries
Last year, GuruFocus introduced the Industry Overview (screener, announcement), a screener that lists industries that have the lowest P/E ratio, the highest dividend yield, the highest profit margins and the highest EBITDA growth. As of this month, the airline industry has the lowest median P/E, the third-highest median five-year dividend growth and the fourth-highest five-year EBITDA growth. This suggests that the airline industry is undervalued compared to other industries and features some hot company stocks.
Allegiant Travel: an undervalued predictable company
Founded and incorporated in Nevada, Allegiant Travel provides transportation services to customers engaging in leisure travel. As of this month, the company has a 4.5-star predictability rank, a financial strength rating of 6 out of 10 and a profitability rank of 9 out of 10. With a margin of safety of 62% based on its discounted earnings valuation, Allegiant Travel is currently one of the most undervalued predictable companies in the U.S. As mentioned in an earlier article, the discounted earnings valuation more accurately calculates the company’s fair value than does the DCF valuation since EPS has a higher correlation with the stock price than free cash flow does.
With several good signs, the Nevada-based airline company has a very strong financial outlook, suggesting very high growth potential. Allegiant Travel has experienced expanding operating margins since 2003, and its current operating margin of 30.02% is higher than 96% of stocks in the global airlines industry. Additionally, the company had consistent per share revenue growth: according to the company’s recent 10-K, Allegiant Travel had increasing total operating revenue during the past three years. Operating expenses decreased in 2015, further increasing net income and return on equity.
Currently, Allegiant Travel has valuation ratios near all-time lows: The company has a P/E ratio close to a five-year low and a P/S ratio close to a two-year low. The current P/S ratio is lower than 87% of companies in the global airlines industry.
Due to the cyclical nature of airline industries, the regular P/E ratio can be artificially low during peak times, according to Peter Lynch. Therefore, the P/S ratio and the Shiller P/E ratio more accurately values cyclical companies. Although Allegiant Travel’s Shiller P/E ratio is greater than its regular P/E ratio, the company’s current Shiller P/E is lower than 71% in the global airlines industry.
Based on his fair value method, Peter Lynch currently values Allegiant Air at $336.25. Historically, the Nevada-based airline company has been increasing Peter Lynch fair values since December 2010, suggesting that the company has been undervalued in the past few years. Additionally, the current price to Peter Lynch fair value of 0.45 is near a 10-year low.
Peter Lynch LUVs Southwest Airlines as well
Like Allegiant Travel, Southwest Airlines has been featured on the Peter Lynch screen in early June. Incorporated in March 1967, the passenger airline company experienced a sharp price decline in early 2016. Based on analyst expectations, Southwest’s stock price is expected to increase steadily in the next two years. This suggests that Southwest Airlines is currently at a discount and a good stock to buy.
In his best-seller, "Beating the Street," Peter Lynch listed several of Southwest’s competitive advantages that allowed the Texas-based company to survive the airline industry meltdown of the 1980s. As Peter Lynch mentioned in his book, Southwest made a “10-bagger,” i.e., increased its price tenfold, while many other airlines went bankrupt. The company’s top two competitive advantages are point-to-point flights and low cost per available seat mile (CASM) values.
With a financial strength rating of 8 out of 10, Southwest has a stronger financial outlook than Allegiant Travel does. Although Southwest has slightly more volatile Piotroski F-scores, the Texas-based airline company’s F-score has been higher than Allegiant Travel’s F-score during the past three years. This suggests that Southwest is less likely to experience bankruptcy in the short term.
Unlike Allegiant Travel, Southwest is not issuing new long-term debt. Consequently, Southwest has significantly higher interest coverage than Allegiant Travel does. Southwest’s current interest coverage of 50.95 is higher than 76% of global airline companies. Furthermore, the Texas airline company has higher cash to debt and equity to asset ratios than does Allegiant Travel.
Gurus increase their positions in hot airline stocks
As the financial outlooks of Southwest and Allegiant Travel strengthen, many gurus are increasing their positions in these stocks. During the first quarter, David Dreman (Trades, Portfolio) bought 50 shares of Allegiant Travel and Ronald Muhlenkamp (Trades, Portfolio) increased his Allegiant Travel stake by 18 basis points (0.18%). Additionally, high-performing guru David Tepper (Trades, Portfolio) added 1.60% to his Southwest Airlines position.
See also
GuruFocus users can implement the All-in-One Guru Screener to find other good airline companies to invest in. In addition to his earnings line, Peter Lynch developed a fast-grower screen with the following criteria: market cap less than $5 billion, debt-to-equity (D/E) ratio less than 0.4, predictability rank higher than 4-stars, five-year EBITDA growth of 20-35%, 10-year EBITDA growth greater than 15% and PEG ratio less than 1. With a D/E ratio of 1.8, Allegiant Travel meets all of the above criteria except for the D/E ratio criterion.
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