At the end of last week, Alaska Air Group, (NYSE:ALK) jumped on speculation that Delta Air Lines (NYSE:DAL) was interested in buying the airline. Investors should not buy the stock based on these rumors; instead, the shares of Alaska are attractive based on the company's strong fundamentals and value proposition.
While the stock popped due to the actions of typical momentum investors jumping in and hoping for a quick buck, the long-term investor should ignore the hype. After the regulatory issues surrounding the American Airlines Group merger, it appears highly unlikely that the regulators would allow another merger involving the three major legacy airlines consolidating the industry.
Even without regulatory issue, it's doubtful that Alaska Air would want to be acquired after successfully rewarding shareholders for so many years, and after having initiated a dividend. The scenario is always worth reviewing to make sure that investors understand the valuation prospects.
The biggest issue with a merger of Alaska Air and Delta is that both airlines are aggressively expanding services in the Northwest. Clearly Delta would love to have Alaska's Seattle hub to expand Pacific flights. Not to mention, a combination of the two airlines would ease the competition brought on by Alaska's expansion plans southward into cities such as Salt Lake City, one of Delta's hubs.
The problem with the consolidation is that all markets in the airline industry are local. Sure the combination would only bring Delta's revenue base up to that of the new American Airlines, but it would greatly reduce competition in the Alaska and Seattle markets. Not to mention, another big issue with allowing the merger would be suggesting that the other two legacy airlines could purchase Hawaiian Holdings (NASDAQ:HA) or JetBlue. How could the Department of Justice approve one and not the others? Suddenly most of the strong regional competitors would be snapped up in another round of consolidation. The DOJ isn't going to allow that at this time.
Alaska Air impressive on its own
According to its presentations, Alaska Air already has the most fuel-efficient operations in the U.S. The airline even has over $500 million of net cash -- astonishing for an airline that has massive capital expenditure requirements for aircraft. Valuation multiples compare very favorably to the industry especially on an EBITDA level. Bloomberg lists Alaska trading around 4.1 times EBITDA with the industry median of 7.4 times. The stock only trades at roughly 11 times forward earnings estimates with analysts expecting long-term growth of 15%. Even better, analysts expect earnings to surge 19% next year.
Alaska Air has plenty of expansion plans in the works with new service from Anchorage to Las Vegas and Phoenix. These flights make Alaska the only airline to offer nonstop service between those destinations. The airline is also expanding nonstop service from Salt Lake City starting in June to Boise, Las Vegas, and San Francisco.
Delta speculation off base
The likely impetus of the rumor on Delta buying Alaska Air was the news that Delta plans to operate 79 daily departures in Seattle to 25 cities by mid-2014, up from 35 flights to 15 destinations now. In fact, Delta might be making this move because Alaska Air balked at a deal or knew that regulatory approval won't happen anyway. By both airlines announcing plans to expand into each others hubs makes absolute no sense that a merger is in the works.
Considering how efficient Alaska Air already runs, it would seem that buying Hawaiian Airlines would provide more opportunity of improving operational efficiency. Currently, Hawaiian has roughly 40% of the revenue base of Alaska, but 10% of the market cap. The main difference in the airlines being the higher passenger revenue per available seat mile, or PRASM, considering that both airlines have similar costs. The operating revenue per available seat mile, or RASM, is no contest -- Alaska Air generates 15.39 cents compared to the 13.57 cents of Hawaiian Airlines.
The nearly 14% difference in RASM suggests the possibility that the Hawaiian market is too competitive and could benefit from consolidation. With Alaska already being one of the best operated and most profitable airlines around, a real concern of consolidation could be disrupting that home-turf dominance already enjoyed by Alaska.
The likelihood of a merger with a legacy airline being approved by the DOJ appears very small. Investors in Alaska Air should focus on its continued strong operations and its plans to create value through expansion, and never bet on whispers about mergers.
Mark Holder has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not 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.