Why Alaska Airlines' Stock Has Room to Climb in 2014

With 2013 winding to a close, it's time to evaluate individual company performances in an industry that has outperformed almost every sector in the broader markets this year: commercial airlines. At a gain of nearly 90% year to date, the Dow Jones U.S. Airlines index has quadrupled the Dow Jones Industrial Average's gain of 21.8%, and likewise swamped the S&P 500 index gain of 26%.In this article, we'll check in on regional standout Alaska Air Group , better known as Alaska Airlines, and determine what the company's recent operational performance may mean for its stock price in 2014.

Debt reduction pays off in 2013
When you get the bug to change your life, determination and a little patience can pay off handsomely. For years, Alaska Airlines' debt burden was a vivid copy of the borrowing incurred by larger airlines in the industry. Twenty years ago, in 1993, the company posted annual revenues of $1.1 billion but held net debt on its books of $465 million. Net debt is the amount by which a company's long-term debt exceeds the cash and marketable securities it has on hand. Ten years later, in 2003, the picture was quite the same, as Alaska held net debt of $301 million.

(Note that net debt is also calculated by only including cash and cash equivalents versus debt, but because most companies today can turn their marketable securities into cash fairly rapidly, you can include marketable securities in the calculation, as I've done here.)


Over the past four years, however, the company has found some religion when it comes to borrowing and reduced its net debt to zero:


 

 Source: Alaska Air Group SEC filings, 2009-2012.

Alaska is using its profits and, by extension, cash generated from those profits to pay down debt. So far in 2013, through Sept. 30, the company has extinguished an additional $139 million of long-term liability from its ledger. This zealous debt shrinkage places Alaska in a position to implement strategies other airlines simply can't. As CEO Brad Tilden noted in the airline's most recent earnings call, the company has used some of its strong cash flow during the trailing 12 months ended Sept. 30 to buy eight aircraft free and clear, a practice rarely contemplated at most airlines.The company now has title to 46 unencumbered Boeing 737s in its fleet, according to Tilden.

What else is a de-leveraged ALK doing with its improving cash flow? The company instituted a dividend in August of this year for the first time since 1992. The $0.20 quarterly dividend equates to an annual yield of roughly 1.13%, leaving plenty of room to grow if the company continues to operate efficiently. 

Alaska's ancillary revenues prowess
As we've discussed previously in "Alaska Airlines' Remarkable Revenue Strategy," the company employs a deft touch with ancillary revenues -- that is, revenue from non-ticket sales, including baggage fees, reservation fees, on-board meals, and the like. In the first nine months of 2013, Alaska increased its "other" revenue category, which captures ancillary revenues, by 11% versus the same period in 2012.Look for the company to capture more incremental travel dollars from its customers in 2014 -- Alaska has placed in the top 10 airlines worldwide in ancillary revenue per passenger for the past two years.


Can higher labor expense lead to productivity?
Although labor is an airline's most significant cost after fuel, Alaska seems to embrace this hurdle as a means to enhance its business, primarily through its variable incentive pay. The company pays out incentives above and beyond salaries for its entire workforce (excluding contractors) every quarter. Last year, total incentive pay earned by employees was equal to more than one month's salary.

Competitive compensation is another priority. In its most recent quarter, Alaska's labor expense drove a 9% increase in non-fuel operating costs, as it inked a new long-term contract with its pilots.Alaska's base wage and incentives compensation strategy is essentially to pay for peak performance. The company doesn't mind increasing wages as long as it sees productivity gains. CFO Brandon Pedersen noted in the most recent earnings call that Alaska's productivity on a passenger-per-employee basis rose by 4% in the quarter.The high productivity of Alaska's employees is manifesting itself on a larger scale: The company ranks No. 1 over the 12 months ended Aug. 31 for on-time performance among large U.S. airlines. 

Can you buy Alaska today despite a swift stock run?
Alaska Airlines stock has gained more than 75% year to date.But because of consistently rising quarterly earnings, the company's P/E ratio stands at a modest 11.3. Though the stock has melted data points on its price chart this year, it still has the potential to reward long-term investors. Let's compare ALK with a cross-section of other regional airlines: Southwest Airlines , Spirit Airlines , Frontier Airlines parent Republic Airways Holdings, and JetBlue Airways .

 Company Trailing-12- Month RevenuesQuarterly Profit MarginDebt to Equity RatioReturn on Invested CapitalDividend YieldP/E Ratio
ALK $5,078 18.56% 0.50 18.92% 1.13% 11.32
LUV $17,440 5.70% 0.41 6.21% 0.91% 20.99
SAVE $1,563 13.38% N/A 23.89% N/A 21.1
RJET $3,400 (4.08%) 3.76 0.92% N/A 24.53
JBLUE $5,270 4.92% 1.41 5.03% N/A

23.55

Sources: Ycharts and company SEC filings. All dollar figures in millions.

With its extremely high quarterly profit margin, similarly impressive return on invested capital -- or ROIC -- and relatively low debt, Alaska is most similar to outperformer Spirit Airlines in this comparison group. Spirit trades at nearly double Alaska's earnings multiple at 21.10. Incidentally, Spirit's debt-to-equity ratio is listed as "N/A" because it carries no long-term debt on its books. Alaska Airlines also compares favorably with the much larger investor favorite Southwest Airlines, which has commanded a higher premium over the years because of its consistent profits and steady earnings growth, and like Spirit, also trades at slightly more than 20 times trailing-12-month earnings. 

A risk in the distance, or, keeping your friends close ...
One risk investors should be aware of is the recent incursion by Alaska's code-sharing partner Delta into Seattle, Alaska's headquarters and main hub. As Fool contributor Adam Levine-Weinberg has noted, Delta wants to increase its West Coast presence in preparation for eventual expansion of its Asian routes. This has led to uncomfortable dealings between the two airlines, as they are now simultaneously sharing revenue in partnered flights and competing for it on Delta's new routes.

Delta benefits from adding its own domestic flights in the Seattle market, but it is ultimately after routes to Asia. Detroit is currently Delta's largest jumping-off point to Asia, servicing about 13,000 weekly seats. But Seattle, a much closer and potentially more profitable gateway to Asia, is not far behind, at approximately 9,000 seats per week.Delta's ambitions in Seattle have injected much complexity into what was once an untroubled relationship of convenience and mutual benefit. Alaska Air Group investors will want to monitor the extent of Delta's increasing Seattle presence in 2014.

Take-away: Alaska will continue to climb
Propelled by its de-leveraged balance sheet, Alaska Air Group is increasingly in control of its own destiny. If the airline sector continues to attract interest in 2014, look for ALK stock to work itself steadily up the price ladder to a valuation closer in line with the more widely followed leaders in its peer group.

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The article Why Alaska Airlines' Stock Has Room to Climb in 2014 originally appeared on Fool.com.

Fool contributor Asit Sharma and The Motley Fool have no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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