In this note, we update estimates following February traffic and declining fuel prices. Our 1Q estimates go up the most for ALK despite only a modest fuel benefit, as revenue growth continues to outpace our expectations. In Exhibit 1 we show all of our estimate changes as well as target price changes.

Airline execs spoke at multiple industry conferences and provided some nominally incremental new news. In fact, most of the new information we learned was a slight negative, including DAL lowering 1Q EBIT margin guidance, DAL raising 2013 capex guidance by $100M (partly due to $30M more capex at Trainer), and soft President’s Day bookings from LCC and JBLU. However, airline stocks ripped over 3% on heavy volume, as investors continue to remain excited about the developing longer term investable themes.

Best idea #1: ALK. We believe ALK is still underappreciated by investors despite the recent run in the stock, as evidenced by its oddly discounted multiple(s) to peers. ALK self-funds high single digit top line growth and new aircraft purchases through robust operating cash flow with enough left over for the biggest share buyback program in the U.S. airline industry. Decelerating growth to Hawaii remains an overrated reason to not be excited about the company’s growth prospects, and the recent AMR/LCC merger should only bolster ALK’s unique and sustainable competitive dynamic: codeshare agreements with huge potential competitors.

Best idea #2: DAL. DAL is a bit more of a consensus call, yes, but the equity multiple still seems to reflect a large degree of investor skepticism about the longer term bull case. DAL’s 19% FCF yield (‘13E) is the highest in the group and the company is years ahead of the industry on capturing merger benefits – but we still see more upside to margins. We also think pension concerns are overblown.

In its 2012 10-K ALK just disclosed, the company only spent $8M buying back stock in 4Q following the Sept. 26 announcement of a $250M share buyback program that should be completed by YE14. And yet ALK still outperformed the XAL airline index by 5pp and the S&P 500 by 24pp in 4Q12. But more importantly the stock is still inexpensive, in our opinion. ALK is blacked out from buying its stock for about half of a given calendar year mainly due to quiet period restrictions. Assuming 250 trading days/year, ALK only has ~250 trading days from YE12 to YE14 to buy back $250M of its stock, an amount that currently equates to 7% of its market cap. A market cap, by the way, that increased ~40% since the launch of the most recent buyback apparently almost entirely due to investor interest and not from its own repurchases.

Venezuelan Bolivar devaluation impact. Venezuela devalued its Bolivar (VEB) by ~32%, effective Feb 13. CPA generates ~10% of its revenue from point-of-sale Venezuelan traffic, and we expect ticket prices to decline on a USD adjusted basis. Back of the envelope math implies that CPA’s FY revenue would decline by ~$70M (10% of our prior $2.6B revenue estimate adjusted by a ~32% currency devaluation for 10.5 months in 2013), but we only expect a ~$15M revenue impact, as we believe CPA can offset most of the impact through higher fares (which they might have already started doing). We use the 2010 devaluation as an example.

With the unsurprising merger of LCC and AMR on widely expected terms we believe, quite simply, that U.S. airline stocks are entering a phase of investability that hasn’t existed since deregulation over thirty years ago.

We are introducing a pro forma model for LCC and AMR with revenue and cost drivers, as well as with historical data. Our pro forma 2014 EPS for a merged LCC/AMR is lower than our standalone 2014 EPS estimate for LCC, but that doesn’t mean we don’t think the companies can’t or shouldn’t merge – in fact we think they will, and should, because of the benefits that address future deficiencies at both airlines, in our opinion. AMR with its massive capital commitments on top of a questionable network strategy and LCC with its current labor dispute providing an ‘artificial’ cost advantage. Still, even if we value LCC equity on our pro forma EPS estimate we still see upside for the stock.

As we wrote in our Friday Flyer last week, the recent run in airline stock prices seems more about multiple expansion rather than higher estimate revisions. Our analysis shows that airline stocks trade at a lower multiple now than they did 18 months ago, so further upside driven by further re-rating of the group seems highly likely if LCC and AMR announce a merger in the near term, as we expect.