The ONLY Stock You Should Buy in This Sector

When nobody expects much from a company, it’s usually pretty easy to please the audience. And there aren’t many sectors that have such low expectations as commercial airlines.

In this bleak industry, it’s often a struggle just to avoid bankruptcy — let alone generate any real profits for shareholders. So when you find a company that’s able to do so, you know you can’t ignore it.

And I know a small airline that does just that. In fact, I think it’s poised to buck the trend of this “hated” group of stocks and post significant gains for shareholders.

If you live in a small city, then you’ve probably heard of Allegiant (Nasdaq: ALGT). But what you may not know is that Allegiant has been able to deliver profits for 36 consecutive quarters. Considering the fact that we’re talking about the airline sector, that’s quite a streak.

What makes Allegiant different from the competition is its focus on small to mid-size cities. While the big boys battle in major hubs such as Atlanta and Chicago, Allegiant has made inroads into 65 less-penetrated markets, including Bangor, Maine; Fayetteville, Arkansas; and Eugene, Oregon. In each case, the company flies only to major resort destinations such as Tampa, Orlando and Los Angeles.

In the interest of full disclosure, I recently booked a direct flight departing from Shreveport, Louisiana, to Las Vegas for about $220. Booking through one of the majors would have cost at least $100 more per person. And it would likely involve the hassle of connecting in a large airport such as Houston or Dallas.

It’s easy to see why leisure travelers like Allegiant. But how is the airline making any money for investors?

For starters, this is a no-frills outfit. You’re not going to get gourmet-quality food and all the latest technology at your fingertips when flying on this airline. Second, having fewer routes reduces expenses. The company also schedules just a few flights per week and can adjust capacity to meet seasonal demands, so there are few empty seats. Finally, most of its fleet comprised of Boeing MD-80s, a low-cost, fuel-efficient aircraft.
The company does spend a bit more on aircraft maintenance than its peer group (which, as a passenger, I don’t mind so much). But it’s able to counteract this with lower expenses from labor, fuel and other miscellaneous costs.
That’s not to say Allegiant is cutting to the bone to attract passengers. It doesn’t have to. The company runs 178 regular routes and only has competition on 12 of them. And if you’ve ever flown with Allegiant (or any other budget airline), then you know the company is also very good at extracting money after you get to the airport — baggage fees, seat reservation fees, snacks, etc.
All of this helps explain why Allegiant sports an operating cost of just $0.109 per available seat mile. This compares favorably even with other low-cost carriers such as JetBlue (Nasdaq: JBLU) at $0.112 and Southwest (NYSE: LUV) at $0.123.
The company also coaxes many of its passengers into bundling their vacation packages. Last year, Allegiant fliers booked more than 570,000 rental car days and 650,000 hotel nights. Ancillary revenue from these third-party operations jumped 19% to $106 million, $30 million of which was gross income. That’s a lofty profit margin of nearly 30%.
Allegiant has grown by leaps and bounds in the past few years. In 2008, the company had 36 planes that flew 4.4 billion miles. Last year, the fleet expanded to 57 planes, flying 6.4 billion miles. During the same time frame, averages fares and ancillary add-ons ticked up 10% to $125.
With heavier volume and stronger pricing, earnings leapt by nearly 50%, rising from $1.73 to $2.57 per share. And in all four quarters of 2011, the firm’s bottom-line total either matched or beat consensus targets.
There should be more of the same in 2012. In the past few months, analysts have already raised their earnings per share (EPS) forecast from $3.88 to $4.01. Some have also lifted their outlook for the stock. Deutsche Bank has raised its share price target from $65 to $75. (The stock currently trades around $58.50.)
All signs point to a banner year. Traffic to the firm’s website is up sharply. Allegiant’s footprint is also expanding into new markets, and the company is adding eight new routes, including Hawaii. At the same time, Southwest Airlines is abandoning 10 to 12 markets where Allegiant operates.
As for departures, management is expecting a 13% to 17% increase this quarter, followed by an even stronger 16% to 20% bounce next quarter.
When times are good, Allegiant generates about $3.5 million in EBITDA from each of its planes. And we’ve just seen 11 new jets enter service, the biggest expansion in company history. This could mean an additional $35 million to $40 million on the bottom line this year, a potential increase of more than 20%.
Risks to Consider: Rising fuel costs, slower leisure travel and air safety concerns all represent potential hazards.
Action to Take –> Those who are afraid of airline stocks can take some solace from the fact that Allegiant has delivered net profits every quarter since 2003. The company routinely posts superior returns on capital in the upper-teens to lower-20s.
The stock is an attractive play on a gradually rebounding labor market and stronger discretionary consumer spending. (Vacation travel tends to spring back before business travel.)
Allegiant Travel started off strong in 2012, with January passenger traffic rising 7% to 417,656 fliers. The shares are already near a 52-week high, but I think they’ll continue to climb, potentially reaching as high as $70.