This is the first of a new quarterly report we will write heading into the new quarter, highlighting upcoming competitive capacity trends (measured by seats, not ASMs) for airlines we cover. For each airline we show which competitors are adding seats, and where appropriate we provide additional color on where those seats are being added.
First and foremost, ALK is a high quality company whose shares we rate as Outperform, and we believe the stock offers reasonable potential upside from here. Having said that, ALK is the only airline we cover where the 2013 strategy in the areas of capacity growth, cash deployment, change fees and bag fees, and/or fuel hedging has not changed since late last year. ALK and its board are conservative when it comes to change and that’s worked well over the last few years, but we believe that conservatism is now being viewed by many investors as complacency.
We just noticed that DAL introduced a second checked bag fee of $100 on Japanese routes as of June 1 while also raising its second checked bag fee from $75 to $100 on other Asian routes. Also, AMR raised its second checked bag fee on European routes from $60 to $100, and on Sunday HA raised its change fees on North American routes from $150 to $200, matching UAL, DAL, LCC, and AMR. All of these fees were introduced this week and we noticed them in our weekly scrub of airline websites. We have yet to see any press coverage, no one has asked us about them, and we’re not holding our breath for a press release.
Shares of ALK are down 19% since its peak in early May, vs. our coverage average (ex-ALK) of -2%, but the decline came well after several disclosures on soft PRASM trends due to competitive capacity incursions. This may mean that a big seller is driving the weakness, but in any light we think the selloff is overdone. Valuation is still interesting, the competitive issues seem unsustainable, and ALK has several levers to pull should it choose to do so in the area of fees, cash deployment, or expense management. ALK’s conservatism in many areas is a source of frustration, but we feel the stock is still mispriced. Exhibit 3 on p.4 shows why.
Not much new information, but it was well attended (held at the NYSE) and we didn’t recognize most attendees. That’s not surprising because many CPA investors limit their airline exposure to CPA. Management didn’t disclose much new info, and all 2013 guidance was affirmed. We did notice 2014 gross capex guidance of $250M (net capex of $140M) was below our prior estimate, which bumps up our free cash flow yield modestly. Absent from the event, however, was an announcement of a special dividend or a stock buyback. We thought there was a slight chance that would happen.
New ways to think about airfares. The price of an airline seat is grossly mispriced relative to its production cost, and this becomes even more evident when comparing airline pricing to other industries like airfreight and even men’s clothing, for example. That’s easily explained by too much supply. Fuel costs and CPI have both risen, so airfare should too, particularly when considering there are no true substitutes for long haul travel and the substitutes that do exist are often more expensive than the actual airfare (like driving or taking the train). We wrote this note to show that pricing still has theoretical room to improve.
Airlines at our conference. This week airlines presented at our 6th Annual Wolfe Research Global Transportation Conference. On Tuesday night we hosted a dinner with UAL management and on Wednesday we hosted three panels: a labor panel (consisting of three pilot unions), a growth airline panel (consisting of ALGT, JBLU, and SAVE), and a network airline panel (consisting of DAL, LCC, and UAL). In this note we provide highlights from the UAL dinner as well as the three panelists.
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?