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Hey, Buffett! This Is the Better Airline Stock to Buy

- By Jonathan Poland

There has been a big vote of confidence from Warren Buffett (Trades, Portfolio)'s Berkshire Hathaway, which has bought stock in the big airlines like American Airlines (AAL), Delta Air Lines (DAL), United Continental (UAL) and Southwest (LUV).


Did Buffett make the trades? Considering the size, probably not. However, with the collective market value of these companies reaching $110 billion, the best trade could be a smaller airline called Allegiant Travel Co. (ALGT).

At the end of October 2015, I wrote about Spirit Airlines ( NASDAQ:SAVE) when it was trading around $37 per share. Today, it is above $53, gaining 34% while the S&P 500 has only risen 5%. With Allegiant's stock down 15% in the last 12 months, a very similar buying opportunity exists.

How interesting is it that four airlines are still just one-third the value of Facebook, which arguably is just a glorified directory to advertise to 1.8 billion people? From a social value, the airline industry crushes almost every other. Yet, until recently, the business has been a net loser for shareholders.

Allegiant is the new Southwest. The low-cost carrier was established in 1997 and has grown to more than 2,800 employees. It is generating over $1.3 billion in sales per year at a solid profit margin. In fact, at 64.7%, the gross margins are better than both Delta and American. This means it will have recurring revenue in good times and bad, and remain profitable longer than most other big-name airlines.

More importantly, Allegiant is investing heavily in fleet revitalization, with 12 new Airbus A320's that the company wants to dominate its fleet by 2020. This is the first time Allegiant has bought new aircraft since going public. This will weigh on EPS in the short term, but provide cost benefits in the long term.

Once the transition is complete, Allegiant will have north of 100 Airbuses in operation and add routes to New York City and the District of Columbia to its destination list. On Nov. 7, the company reported revenue passenger miles increased 14.4% in October to 766.193 million and capacity had risen 15.3% to 922.715 million available seat miles. However, revenue per available seat mile fell in October. During the third quarter, the company's EPS and revenue both beat estimates, but the future is what matters at this point.

Fluctuations will continue to be more common in this industry than in others. I also feel torn between Berkshire's practice of buying into old industries that have not been good for shareholders (e.g. railroads, automobiles, airlines) and common sense of what is going to produce the best returns for investor capital.

In the case for Allegiant, the airline has absolutely crushed it over the past decade. It grew sales from $243 million to $1.3 billion, its book value from 3.05 to 26.73 and its EPS from 52 cents to $14.12 over the last 12 months. Guess what the stock price did? Crushed it, rising from $28 in 2006 to just under $158 a share currently.

What is awesome here is Allegiant expanded its gross margins by 50% while controlling its capital spending pretty well. But, most of the major airlines spend more in capital expenditure than they produce in net income. For example, Southwest spends over 100% of its net income every year in capital expenditure, going back over 10 years.

Throw that fundamental value tenet out the door!

The bigger problem for the industry as a whole is what happens when oil and gas prices rise. It may be true that society is moving toward electric and autonomous vehicles, but when it comes to airplanes, there are no alternative energy sources to jet fuel. With that said, many analysts think that the impact of capacity discipline is more important than lower fuel spending.

Only time will tell if the industry as a whole can sustain this amazing streak of profitability, but Allegiant is priced at just $2.55 billion, one-tenth the price of the big four, and still has a lot of growth potential. In the worst case, the company is acquired prematurely. In the best case, it carves out its own $20 billion chunk of the industry.

Dicslosure: I do not own any of the stocks highlighted in this article.

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This article first appeared on GuruFocus.