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"The worst sort of business is one that grows rapidly, requires significant capital to engender the growth, and then earns little or no money. Think airlines. Here a durable competitive advantage has proven elusive ever since the Wright Brothers. Indeed, if a farsighted capitalist had been present at Kitty Hawk, he would have done his successors a huge favor by shooting Orville down."
-- Warren Buffett
Aside from being an unbelievably hilarious quote, it's also mostly true. The airline sector in general is not a good investment. Between rising fuel costs, labor unions, capital expenditures that seem to rise with the blink of an eye, and even acts of God, the sector just seems to have the deck stacked against it. Sometimes there's no way to see disaster coming, as with the tragic terrorist attacks in 2001, but other red flags (at least to me) appear as clear as day and night, as with the bankruptcy rumors currently surrounding AMR (NYSE: AMR ) .
So you may be wondering, "Who would be sadistic enough to recommend buying into a sector in which the deck is stacked against it from the beginning?" Why, me, of course! If you carefully examine the sector beyond just the largest airlines, you'll discover three smaller companies that have built up a good customer following and do have competitive advantages over their larger counterparts. Although these three companies aren't screaming buys, their balance of value and growth makes them attractive candidates for further research.
Allegiant Travel (Nasdaq: ALGT )
If the name looks familiar, that's because it's one of my small caps to rule them all. Allegiant Travel, a leisure travel company that transports passengers from small cities to leisure destinations, has now reported 34 consecutive profitable quarters. How's that for growth, Mr. Buffett? If that's not enough, Allegiant sports a five-year compounded annual revenue growth of 38.1%, miles away from the next closest airline, Republic Airways (Nasdaq: RJET ) , at 24%.
Allegiant is able to maintain its standing as one of the leaders in operating efficiency because, unlike larger airlines, it will simply ground routes that become unprofitable -- what a concept, right? By also charging for all food and beverages, and purchasing an older fleet of planes, the company is able to focus on profit rather than revenue maximization. With a $175 million net cash balance and at 12.5 times forward earnings, Allegiant has a valuation that may just be too good to pass up.
JetBlue (Nasdaq: JBLU )
Another regional airline, JetBlue is slowly seeing its stock dragged down to the low single digits despite results that would signify just the opposite. Although JetBlue hasn't produced growth anywhere near what we've seen from Allegiant, it clearly deserves more respect than it's currently receiving at just 8 times forward earnings.
Although JetBlue's second-quarter results didn't thrill investors, the July and August passenger-traffic reports since then have me excited. In August, traffic rose by 5.8%, with the more important traffic revenue per available seat mile rising by 7%. These figures are important because they signal not only JetBlue's ability to pass along rising prices, but also its passengers; willingness to accept those price increases and continue traveling. Based on the fact that fuel costs were 44% higher than in the year-ago period, JetBlue's ability to pass along price increases and maintain profitability makes it a company worth exploring further.
Alaska Airlines (NYSE: ALK )
You're reading that correctly; Alaska Airlines and not Motley Fool longtime favorite Southwest Airlines (NYSE: LUV ) . The reason I prefer Alaska over Southwest has to do with the company's four-year run as top among JD Power's customer-satisfaction survey. Keep in mind I'm not putting all of my eggs in one basket just because of one survey, but Alaska boasted an on-time performance of 90.7%, behind only Hawaiian Airlines (NYSE: HA ) , and its relatively low baggage fees are easily responsible for attracting a growing customer base.
Only Alaska Airlines could find a way to turn a 48.5% rise in fuel costs into a positive. During the second quarter, the company was able to increase revenue by 13.7%, which, when added to its fuel-hedging strategies, was more than enough to cover the negative effect of increasing fuel costs. Alaska Airlines ended the quarter with $1.2 billion in cash, which put the company's debt-to-total capitalization ratio at 63%, its lowest level since 1999. Alaska just keeps grinding out profits and happy customers, period!
Warren Buffett is clearly a smart man, but he failed to take notice that there are indeed competitive advantages in the airline sector -- they just don't stand out like a big red truck as they do in other sectors. Smaller regional airlines are often able to cater more personally to consumers, creating a more favorable travel experience and boosting bottom lines. Allegiant, JetBlue, and Alaska all exhibit to some degree a competitive advantage over their larger peers and thus make for a compelling buy in a sector otherwise devoid of value.
What do you think? Are you willing to purchase airline stocks, or do you just keep your distance? Share your thoughts below, and consider adding Allegiant Travel, JetBlue, and Alaska Airlines to your free and personalized Watchlist to keep up on the latest news with each company.