Investment Thesis
Airlines have a bad reputation with many investors because of their low profit margins and cyclical nature of the business. Allegiant Travel Company (NASDAQ:ALGT) has lived up to the bad reputation of airline stocks over the past year with shares down more than 50%.
In this analysis, I examine what caused Allegiant’s demise and what steps management have taken to address the issues. Because of the poor price action of Allegiant, it qualifies for investment only to those investors who are truly contrarian. I’ve personally written about and invested in several “falling knives” opportunities. Allegiant fits many of the criteria that I look for in “falling knives”.
Based on my findings outlined below, I’m issuing a Buy rating for Allegiant.
What Caused The Drop
One key factor in the profitability of airlines is the rate of air fares. This year, rates have come down gradually:
- In January 2024, it was reported that fares had fallen in December of 2023.
- In May 2024, reporting showed that fares fell in April as the busy summer season approached.
- Fares then fell 5.9 % in May compared to a year prior.
- In July, it was then reported that rates had taken another drop in June, extending the drops to a four month streak.
- Fares continued downward in July.
These fare drops have negatively impacted Allegiant’s financial performance during the year.
On top of this, analysts have soured on low-cost airlines. In July, Deutsche Bank downgraded Allegiant from a “Buy” to a “Hold” rating.
Downgrades by analysts tend to negatively impact share prices. This time was no different as Allegiant shed 2.7% after the downgrade. While Deutsche Bank acknowledged that full-service carriers were reporting significantly better results than a year prior, they also observed that:
The majority of the industry’s top-line growth and operating profit will be generated by the full-service carriers […] Most low fare carriers, on the other hand, continue to struggle financially with several projected to report losses during what is typically the industry’s strongest quarter for air travel demand – Michael Linenberg, analyst, Deutsche Bank
In spite of air fares dropping and analysts turning on the stock, Allegiant actually has a history of beating on EPS and revenue estimates in recent quarters:
- In February, Allegiant beat against EPS and revenue expectations.
- In May, the company repeated their surprise performance and delivered revenue and earnings above expectations.
- In July, Allegiant reported another beat on both top and bottom lines as non-GAAP EPS came in at $1.77 (a beat by an entire $1.01) with revenue beating by a little over $8 million to come in at $666.3 million.
Often, consistently beating on estimates will create a technical upward pressure on the stock price. With Allegiant, this hasn’t been the case because of the challenging business environment concerning fares. This leaves management with lots of action to take – something I’ll look into below.
Qualitative Actions Management Have Taken
On their most recent earnings call, Allegiant revealed that one of their main thrusts for more revenue would come in the form of simply flying more. According to management, the existing fleet and personnel can deliver more flying hours, and that flying will be concentrated on peak periods. Aside from being revenue accretive, this should drive down unit costs.
The increased flying comes against the backdrop of a challenged low-fare segment of the aviation industry.
Departing Allegiant CEO and founder, Maury Gallagher, delivered an interestingly candid analysis on where low-cost carriers stand against their larger peers:
A combination of weakening revenues, substantial cost increases, poor reputation and brand has condemned a number of the industry’s low fare players to a loss situation that will be hard to turn around. – Maury Gallagher, Allegiant CEO
Maury Gallagher went on to describe how the Airline Deregulation Act of 1978 had been the best outcome for the US traveling public and carriers alike, then describing how a tougher regulatory environment in recent years – in his opinion – had undermined business models of low-cost carriers:
The magnitude of these changes almost certainly suggests losses will increase near term. On the regulatory front, I worry about the efforts that the federal government is working to fix something that is not broken. – Maury Gallagher, Allegiant CEO
It’s not only bad news for low-costs carriers like Allegiant, though: The Department of Transportation had recently introduced new regulation, including the ancillary fee rule. This would’ve required airlines to rewrite their websites to comply with how the DOT wants airlines to present its services and pricing. The Fifth Circuit Court issued a motion to stay the implementation of the ancillary fee rule, something that for the time being has saved airlines millions of dollars.
Even so, regulatory pressure keeps mounting. In an attempt to better compete with the majors, Spirit Airlines (SAVE) and JetBlue Airways (JBLU) planned on merging, but as the merger was blocked, both airlines remain sole entities with much smaller fleets than that of the majors. While the argument against the merger is that more competitors means more competition, the counter-argument is that when smaller airlines can’t merge, it insulates the major carriers from competition outside of the other majors – and dooms the smaller carriers in the long run.
Maury Gallagher put it nicely on Allegiant’s earnings call:
… when a current carrier’s business does not work, there’s only one of two options, you go out of business or you merge. – Maury Gallagher, Allegiant CEO
Accordingly, the CEO said he expected the majors’ market share to go up in the coming years.
So what sets Allegiant apart from the other low-cost carriers? Well, as noted by Mr. Gallagher – who has a large stake in the business – out of all routes Allegiant serves, 75% of them are non-competitive. This strong focus on underserved routes should keep Allegiant unique – and profitable.
This Quantitative Signal Suggests Future Outperformance
With companies in distress, conventional key figures like the P/E and P/FCF often don’t work because such companies tend not to generate earnings or free cash flow. If you screen for traditional value stocks based on these metrics, you will exclude many distressed companies and miss some interesting opportunities for significant and profitable rebounds. A more appropriate metric for these issues is the EV/R ratio. It describes the relationship between the price for absolute control (all stocks and bonds bought at market) and the revenue generated by the business.
Allegiant has an EV/R ratio of just 0.92. This is quite low compared to some of its peers: Spirit (SAVE) with an E/VR of 1.34, Frontier (ULCC) with an EV/R of 1.17, Sun Country (SNCY) with an EV/R of 1.05, although higher than Southwest (LUV) with an E/VR of 0.60.
Allegiant’s very depressed EV/R ratio to me signals on a quantitative level an interesting opportunity for mean reversion.
Risks
The macro pressures on Allegiant are obvious: Fares are highly volatile and subject to influences outside of Allegiant’s control. The regulatory environment is toughening. And low-fare airlines are out of favor with the market in general.
On a more company-specific level, Allegiant must maintain their strong position with non-competitive routes. There’s a chance that Allegiant would benefit if other low-cost carriers go out of business because of the general business environment that low-cost carriers operate in – but then there’s also the chance that others will attempt to catch up with Allegiant’s business model and start competing more on the routes that Allegiant focus on. These are serious risks that any potential investor should consider.
Key Takeaways
Allegiant is a low-cost carrier challenged by declining air fares and the tough regulatory environment in which carriers operate. Shares are down more than 50% in the past year.
This presents an interesting buying opportunity, however: Management is focused on increasing flying and revenue – and on maintaining the company’s strong position in low-competition routes.
Allegiant has an EV/R ratio of just 0.92. That’s lower than most of its peers and quite a low figure in general. This could signal undervaluation on a quantitative level.
For the reasons stated above, I rate Allegiant a Buy.
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