Description

The Allegiant Travel Co., ticker ALGT, is an ULCC (ultra low cost carrier) airline.  It’s a little under a $3bn market cap and trades a touch thin at ~$20mm / day.  The stock is interesting today because the Company has been going through a fleet transition, and after a couple of years of stagnating and declining margins, earnings are inflecting back up this year and are poised to grow double digits in a somewhat mechanical fashion over the next several years.  To put some numbers around it, they should do close to $12 of EPS this year, $16 in 2019, and $20 in 2020.  Admittedly the stock has run a bit recently as the market started to appreciate the inflection, but at ~$175, it’s still trading at less than 9x 2020 earnings while growing earnings approximately ~30%, and the street isn’t there.  Management held an investor day in December and laid out the key assumptions making it quite easy to model.  The algorithm is predicated on low teens ASM growth with an all Airbus fleet that will be ~80 planes at the end of this year and 110 planes by the end of 2020.  They’ve got labor contracts negotiated, they have routes mapped out for the next 3-5 years, the maintenance and other expenses are essentially formulaic, so other than bad execution, the key variables to flex are mainly unit revenue growth and the cost of jet fuel, which can of course be hedged if needed.             

The other attractive aspect of the situation is that Allegiant operates a very unique business model.  For anyone following the airline industry, there’s been a big scare with United’s recent plans to rapidly expand capacity.  Nonetheless, Allegiant basically operates in its own world, and due to the unique business model, they only have competition on ~20% of their routes and should be largely unaffected.  What they basically do is go into very small, underserved cities and take leisure travelers from places like Cedar Rapids, Iowa to vacation destinations like Orlando and Las Vegas.  They’re solely focused on leisure customers and offer a ‘no frills’, unbundled product with a very low fare averaging ~$70, and then offer some ancillary upgrades for baggage, etc. that totals another ~$45.  Now operating for about 20 years, the Company generates $1.5bn of revenue and flies ~400 routes that connect ~100 small/medium-size cities to ~20 leisure destinations.  What’s nice is this still represents only ~1% of the domestic airline industry and so not only are they stimulating new demand in these small markets, but they are essentially inconsequential to the majority of other carriers.  Further, in speaking with IR, they have ~500 more routes mapped out to cover ASM growth for the next 3-5 years.  Often times when they come into one of these small markets, there’s very little other air service that’s nearby or affordable and Allegiant actually opens up vacation alternatives to families stuck in places like Fargo, North Dakota.  

The last key point is that you’ll be investing alongside Maury Gallagher, the founder and Chairman who still owns ~20% of the company.  Maury is an airline industry veteran who built this business from scratch.  He’s not only a great operator, but he instills a frugal, ‘think like an owner’ culture and he is obviously very aligned with shareholders.  He stepped back from most of the day-to-day a couple years ago and given his age and his wealth concentration, it’s not farfetched to see this business ultimately get sold in the next few years.  More near-term, Frontier, another ULCC and probably Allegiant’s closest competitor, is likely to buy Spirit and a bit of consolidation amongst the ULCC carriers would be a positive for everyone. 

In terms of risks, the bears come at the stock with a multi-pronged thesis.  First, it’s an airline which brings all of the associated baggage, yet it also trades at the richest multiple of the group at ~14x vs airline peers now sporting HSD multiples.  To this I would remind everyone that Allegiant largely operates in its own world with little competition, has industry leading margins, has double digit topline growth, and is poised to grow earnings ~30% over the next several years.  For what it’s worth, the Company has basically always traded for a high-teens multiple, irrespective of the group, except during the great recession and the recent fleet transition where the stock bottomed at 10x times in each instance.  Further, the airline industry as a whole is probably a bit oversold and so there may be interesting opportunities among the larger traditional carriers.  The next key point is that people worry the business model is forever impaired after this fleet transition where the Company swapped out very cheap MD80 aircraft for more expensive Airbus aircraft.  There is some validity here in the sense that unit economics have certainly come down.  The Company used to purchase MD80’s for $3-5mm and each plane would do about ~$3.5mm of EBITDA representing cash on cash returns upwards of ~100%.  Now the Company is buying used Airbus aircraft for ~$15mm and will do $3-5mm of EBITDA per plane.  So no longer will they generate 100% returns, but returns are still north of 20%+.  Finally, and perhaps the most distracting, bears will point to the condo development project the Company is currently evaluating.  While it’s obviously a bit of a red flag when a business strays from their core competency, the team focused on this project is operating in its own silo and the maximum risk to Allegiant would be limited to a ~$125mm non-recourse contribution (a small fraction of the ~$3bn market cap company).  Moreover, the project is still in a pre-development evaluation stage and Maury is not going to move forward unless the investment is both de-risked financially and attractive from a returns perspective.

In summary, Allegiant represents a unique business model led by an economically aligned CEO that trades for an attractive multiple given the 30% earnings growth CAGR going forward.  With the fleet transition and associated cost step-up in the rearview, all the Company has to do is take delivery of the contracted Airbus fleet and execute as they have consistently done over the past decade.  If the Company hits $16 EPS in 2019 and $20 in 2020 per the algorithm, a mid-teens multiple (the lower end of the historical range) gets you to a stock price of $240 and $300 in 2019 and 2020 respectively representing 70% upside over the next couple of years.  If oil rises a bit and/or the Company fails to execute in as profitable a manner as advertised, $13 of EPS at a de-rated 10x gets you to $130 for 25% downside.  As a final sanity check, the Company guided to $5mm of pro forma EBIT per plane on the all Airbus fleet which compares to $4.3mm of EBIT per plane in the ~$20 EPS scenario.  EPS would in fact be closer to ~$24.50 if they hit that $5mm number, and feel free to pick a multiple, but that could translate to a $370+ stock in a super ‘blue sky’ scenario.     

Catalyst

Earnings over the next couple of years (growing ~30%), ULCC airline consolidation (Frontier + Spirit), healthy industry RASM trends admidst capacity increases, Sale of the business