We just noticed JBLU modified its change fee structure effective last Friday May 17, and we think the change will be earnings accretive. Recall in late April UAL raised its change fees by ~$50 across its system and over the following week LCC, DAL, and AMR all matched. JBLU is the first “non-network” airline we have noticed that is now participating in the increase. We haven’t seen any media coverage picking up this change.
Incrementally negative disclosures from ALK this week on PRASM, but the stock rallied with the group on Wednesday as airlines presented at a conference. ALK also disclosed negative commentary on demand trends in its 10-Q last week, including “…over 30% of our ASMs are experiencing negative yields due to competitive pressure.” April PRASM fell -4.6%, and 2Q PRASM might be “tough” per mgmt.
Equity valuation and airlines: a relationship of inconvenience. Last year we wrote a piece called “New ways to think about airlines and valuation,” and in it we tried to address an issue that we think many investors struggle with in airlines: which multiple to use, and what’s a reasonable target for that multiple?
We reviewed proxy statements for all airlines we cover and aggregated the drivers of variable compensation (both short term and long term) among senior executives. We also highlight the changes from last year’s proxy statements as well as changes from the proxy statements in 2008, before the industry dramatically reshaped itself though difficult capacity cuts, mergers, and ancillary revenue initiatives. Lastly, we reviewed insider ownership levels and found mixed results.
We monitor PRASM trends with a regression model we call The Wolfe Research PRASM Forecaster, which we’ve developed using a number of leading indicators, and back tested for accuracy. After observing the April data points (which provide a ~three month lead time for PRASM into July) we see the recent rebound off the trough April continuing into the summer months through July. Two of the many components of the PRASM Forecaster, the S&P 500 and inverted jobless claims, have had a >0.90 correlation to monthly PRASM data over that last five years when advanced by three months. This week the S&P 500 hit another new all-time high and unemployment claims just hit a post-crisis low.
As the industry has transformed over the last several years we believe barriers to entry have been raised largely due to fuel price volatility and consolidation – not coincidentally two of the main components to our bull thesis on airlines. When we pitch an airline bull case to potential new airline equity investors, the barriers to entry concern is usually the biggest pushback we hear.
We’ve included ROIC in our models for about two years, but now we’re adding weighted average cost of capital (WACC) to all of our models to provide context for that ROIC. Our calculation of ROIC is conservative and produces a figure lower than every method used by every U.S. airline, and our WACC calculation is perhaps just as conservative, if not also creative. Download our models to check it out.
DAL raises domestic change fees. At about 2:30 PM ET today we noticed on DAL’s fee disclosure webpage that DAL’s domestic change fee is now $200, up from $150 previously. We’ve literally been hitting refresh on delta.com for a week, waiting for this to hit. DAL matched the higher change fee from UAL and LCC last week. DAL’s international change fees are still $250 for most routes, although it “varies by location.” Note UAL and LCC both selectively raised some international routes from $250 to $300. We believe DAL’s new fees are not yet widely known, and we also think investors underestimate the magnitude of this accretion to EPS.
Solid quarter from ALK, with EPS of $0.62 above our estimate of $0.58 on revenues and costs. ALK’s crisp execution and steady value creation should leave little else to be desired from investors. In our opinion, the multiple that the market assigns ALK equity is flawed and it seemingly disregards ALK’s underrated growth prospects, consistent value creation, and further cash flow optionality. ALK is arguably over-investing in its business this year with capex of more than 2x D&A, yet free cash flow is still sufficient to generate a 6% yield – among the highest in our coverage.
LCC matched UAL’s change fee, increasing the cost to change a ticket by $50 in all regions except the transatlantic (that fee is unchanged at $250) following UAL’s announcement of higher change fees. We estimate this change alone could be worth at least 10% annual EPS accretion for LCC, UAL, and DAL. For now, we aren’t updating our estimates until we see DAL match LCC and UAL (but we think they will). We believe this is not yet widely known by investors, and we haven’t seen any media coverage on LCC’s decision to raise the fee.