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Holly LaFon
Holly LaFon
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Royce Funds: A Contrarian Value Investor on Two Airlines He Likes

Portfolio Manager Jay Kaplan talks about the changing airline industry and two small-cap carriers that have drawn his interest

February 27, 2018 | About:

Watch the video here.

Where are the small-cap opportunities in airlines?

The airline industry has changed. Historically it's always been viewed as an industry where no one made a nickel, it's capital-intensive. If you don't fill the seat at the end of the day, it's like spoiled meat, it goes rotten, you throw it away.

There's been a lot of change. Bankruptcies and consolidations have made the industry pretty much an oligopoly in the US. You have a small number of major carriers who are basically chasing business travel, adding capacity smartly. Planes are full, prices are good. That has left some room for leisure travel. So there are some upstart low cost airlines that are catering to the leisure traveler, flying small cities, leisure markets, not every day, one or two flights a day, and we found some of those are pretty interesting.

Which airlines are you excited about?

Let me talk about two, Spirit (NYSE:SAVE) and Allegiant (NASDAQ:ALGT). Spirit is growing very, very quickly. It's really profitable, and has done very, very well. But it's going to some markets against United, and United's gotten angry and has retaliated with low prices, and the stock market hates that, and has put the stock on sale. We've seen that before, we saw it about a year-and-a-half ago with American. At some point American backed off. I suspect United will as well. It's not in their interest to keep prices low, because then they'll have to charge business travelers low prices, and that doesn't make sense, because business travelers will pay.

The second idea is Allegiant. Allegiant flies from very small markets to leisure markets like Las Vegas, and it grew up with very old airplanes. It's one of the few airlines that still flies MD80s, and they're getting very hard to service, so Allegiant is replacing their entire fleet. When you do that, you carry a lot of spare parts, a lot of extra people, and you need to retrain every pilot for the new aircraft you're taking on. This is taking about two years. When it's done, it'll be a better, more competitive airline, but in the meantime, Wall Street doesn't have any patience, and for us, that presents opportunity.

What are the misperceptions about the industry?

I think the misperception in airlines goes back to the history of the airline industry. It's been an absolutely awful business, very capital-intensive, no returns on capital, cash-flow-using. And when times get tough, the behavior had been bad, prices were cut, and profits went away. Now we've had consolidation, bankruptcies, better cost structures, oligopoly, and good behavior, with full airplanes. So at the moment it's all systems go.

In the low-cost carriers that we've invested in, leisure travel is very important, and there are two areas where that's growing. We have a growing retiree population. They're price-sensitive, which is really good for the low-cost airlines, and they'll fly off-peak days and off-peak times, so that's perfect for an Allegiant. In the case of a Spirit, for example, millennials love experiences and don't want to spend a lot of money, so a millennial can cheaply hop on a plane for a weekend experience, and that's a great business for Spirit.

Important Disclosure Information

The thoughts and opinions expressed in the video are solely those of the persons speaking as of January 9, 2018 and may differ from those of other Royce investment professionals, or the firm as a whole. There can be no assurance with regard to future market movements.Company examples are for illustrative purposes only. This does not constitute a recommendation to buy or sell any stock. There can be no assurance that the securities mentioned in this piece will be included in any Fund’s portfolio in the future.

The performance data and trends outlined in this presentation are presented for illustrative purposes only. Past performance is no guarantee of future results. Historical market trends are not necessarily indicative of future market movements.

This material is not authorized for distribution unless preceded or accompanied by a current prospectus. Please read the prospectuscarefully before investing or sending money. The Fund invests primarily in small-cap stocks, which may involve considerably more risk than investing in larger-cap stocks. (Please see "Primary Risks for Fund Investors" in the prospectus.) The Fund’s broadly diversified portfolio does not ensure a profit or guarantee against loss. The Fund may invest up to 25% of its net assets (measured at the time of investment) in securities of companies headquartered in foreign countries, which may involve political, economic, currency, and other risks not encountered in U.S. investments. (Please see "Investing Foreign Securities" in the prospectus.)

About the author:

Holly LaFon
I'm a financial journalist with a master of science in journalism from Medill at Northwestern University.

Visit Holly LaFon's Website


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