Airline stocks have generated phenomenal returns for investors for the past couple of years. Numerous airline stocks have doubled or even tripled since the beginning of 2013. Naturally, many investors are wondering whether there are any bargains left in the airline industry.
We rounded up three Motley Fool contributors to get their best ideas about which airline stocks investors should consider for their portfolios today. They picked Alaska Air Group (NYSE:ALK), Volaris (NYSE:VLRS), and Air Lease (NYSE:AL). Read on to learn why all three stocks have market-beating potential.
Asit Sharma: Consider Alaska Air Group as a core holding for your airlines portfolio. The company is attractively valued at roughly 10 times forward earnings. It's also one of the best-run domestic carriers, leading major airlines in profit margin, safety, and on-time performance. Alaska Air enjoys status as one of just a handful of airlines worldwide to carry an investment-grade credit rating.
Alaska Air has weathered Delta's incursion into its home base of Seattle by opening up new routes eastward, and upgrading its fleet of Boeing 737-400s to the more efficient 737-900ER (Extended Range) aircraft. Despite an onslaught of new flights added by its mammoth competitor over the last two years, Alaska continues to post record revenue and profits. While Delta will inevitably trim off some of Alaska's business, the company is more than sound enough to absorb Delta's challenges over the long term. Moreover, some investor skepticism is already priced into the stock.
Alaska is one of the better positioned airlines to take advantage of low oil prices. The company employs a very simple hedging practice, purchasing call options to offset upward trends in jet fuel prices. By avoiding more complex strategies designed to lock in pricing, Alaska fully realizes the benefit when oil prices decline, while generating minimal cost to protect against upside movements.
All of the advantages above are perpetuated by a workforce that participates in a variable incentive pay plan aligned to company goals. In recent years, Alaska Air employees have received an annual bonus equal to one month's compensation -- that's a significant assurance to investors who wonder if the company will continue to operate at the peak level of the last few years.
Adam Levine-Weinberg: Mexican ultra-low cost carrier Volaris completed its IPO in late 2013 -- and its profitability promptly fell off a cliff. Recently, results have improved dramatically, but the stock still trades at a discount to its $12 IPO price. This makes it a great bargain.
For the first half of 2014, Volaris' operating margin plummeted by nearly 12 percentage points year over year to negative 9.6%. Overcapacity in the Mexican market drove down fares to a point where Volaris could not break even, despite its industry-leading cost structure.
However, Volaris made a strong recovery in the second half of 2014 and managed to eke out a full-year profit. The biggest improvement came in Q4, as operating margin rose a stunning 17 percentage points year-over-year to 10.8%.
Results are likely to get even better in 2015, as Volaris takes full advantage of the recent drop in oil prices. Volaris also plans to grow its international capacity 33%-36% this year to exploit strong demand in the U.S., while growing only 2%-4% in Mexico. This should keep total unit revenue rising at a healthy clip (it increased more than 20% in local currency last quarter).
Volaris stock rose above $10 for the first time in a year on Thursday. But based on its recent trajectory, EPS could surge to $1 or more in 2015, justifying a much higher valuation. Investors should be prepared for more volatility with Volaris, as the Mexican air travel market is far from mature, but the rewards could be spectacular.
Maxx Chatsko: I'm bending the rules a little bit here, but air leasing company Air Lease is my pick. The company acquires new fuel-efficient aircraft and lends them to airlines that don't have the capital or financial flexibility to purchase new aircraft themselves. Air Lease collects low-cost revenue from a diverse stream of customers, and those customers are able to fly modern, fuel-efficient aircraft for strategic routes. Leasing aircraft can be a valuable part of any airline's growth strategy, especially considering that fuel is one of the single biggest expenses for an airline.
Air Lease has a unique twist on its business strategy compared to other air leasing companies, however. At any given time, the company's global fleet will contain roughly 200 aircraft, rather than growing with abandon. As new aircraft are continuously acquired, older aircraft will be continuously sold in order to maintain the youngest stable of planes in the world. The strategy also keeps the high levels of debt necessary for playing in the industry relatively stable.
So far, so good. The air lessor has steadily grown revenue, net income, and EPS every quarter for the last several years. That includes growing revenue from $336 million in 2011 to over $1 billion in 2014. Throw in a new joint venture with plans to acquire up to $2 billion in new aircraft in the next two years and a recent debt financing that boosted cash reserves to $800 million (more than double the highest previous level), and Air Lease doesn't appear to be slowing down anytime soon.