Ever since Warren Buffett disclosed an ownership stake above 10% in Delta Airlines, Wall Street is mad on airline stocks. Since his announcement, the NYSE Arca airline index, an index that tracks the performance of publicly traded airline companies, is up by 2.74%. So, this week I looked at buying Delta shares but ended up owning shares in Hawaiian Airlines instead. And this story is the subject of this week's meditation.
In January of this year, I flew to New York with Delta. It was a fantastic experience. The airplane left the terminal on time, the staff was courteous and professional, the seats were comfortable and the breakfast served in the Delta lounge at JFK was so remarkable that I practically ate for two people. It does not surprise me that Delta was named the top U.S. airline in the WSJ's Middle Seat Scorecard.
Was flying with Delta a wonderful experience? Yes. But is Delta's stock reasonably priced? No. At $57 per share, Delta Airlines (DAL on Nyse) trades at a 15-year high. In 2018 the price peaked at $60.71 which is not far from its current pricing. Delta shares trade at about 9 times the 2018 earnings per share and about 2.5 times the book value. Compare that to Hawaiian Airlines, which trades at less than 6 times the 2018 earning per share and at about 1.4 times the reported book value.
For Marty Whitman, of Blessed Memory, purchasing a stock at 1.4 times its book value would be outrageously expensive. He emphatically wrote, "At Third Avenue, we only acquire interest in companies where the common stock is selling at prices that reflect a discount from readily ascertainable Net Asset Value as of the latest balance sheet date."
So, to meet his standards, I was determined to adjust the book value. Reference page 33 of the 10-k report where management says that, "$603.7 million of our current liabilities are related to our advanced ticket sales and frequent flyer deferred revenue, both of which largely represent revenue to be recognized for travel within the next 12 months and not actual cash outlays." Post the adjustment for non-cash outlay, at the $27 per share, Hawaiian trades at par.
Reflecting on another of Whitman’s famous sayings, "A bargain that stays a bargain is not a bargain," I wondered whether Hawaiian’s current valuation was appropriate. Between 2015 and 2017, the average price to earnings per share were 13 times. And during that 3-year timeline, the average price to book value was 3 times.
Not only is Hawaiian’s current valuation below its prior years' valuations, it is also less than what low-fare airline companies, such as Allegiant AIR (ALGT on Nasdaq) and Spirit Airlines (SAVE on Nyse), are trading for. With a market capitalization of $2.21 billion, ALGT traded at 14 times the earnings per share and 3 times the book value. With $3.71 billion in market capitalization, SAVE traded at 24 times the earnings per share and 2 times the book value.
Not a single airline traded at less than double digits valuation to earnings per share, the average 10-year EPS for the Hawaiian's peer group was $2.49, practically identical to Hawaiian’s 10-year earnings per share of $2.53, not a single airlines traded at less than 2 times the book value, the average 10-year earnings per share for the peer group was 18 times and the 10-year average earnings per share for Hawaiian was 11 times.
Hawaiian’s current valuation is attractive. But its management is even more. The first noble thing management did was to buy its own stock. In the fourth quarter of last year, management bought 1.42 million shares at about $33 per share, which cost the company $48.96 million. The board of directors budgeted up to $100 million by December 2019. And an additional $100 million may be bought by December 2020.
The second noble thing is that management shares with readers how it measures the performance of the business. Management shares metrics, such as Passenger Revenue Per RPM, also known as Yield in the industry, which measures how much profit is earned for every mile of flight. It also explains in detail what the RAPM is (Passenger load factor per Available Seat Mile, a measure that tracks efficiency). For the long-term investor, reading annual reports from Hawaiian has an educational purpose.
Peter Ingram, Hawaiian’s boss, has been with the company since November 2005. He owns almost 300,000 shares now worth about $8.7 million. He is the largest private shareholder excluding Larry Hershfield, who owns about 350,000 shares. As a side note, Hershfield is the founder of Ranch Capital, an investment fund that specializes in growth opportunities.
The current hype over airlines stocks, like most things in life, is temporary. Students of financial history will note that Delta sought protection from its creditors under Chapter 11 in September 2005. Two months prior to that, Hawaiian filed for Chapter 11 for the second time in its history.
Legendary value investors, such as Peter Lynch, Mario Gabelli and Warren Buffet owned U.S. Airways stock that went into bankruptcy too. Perhaps, Richard Branson, founder of Virgin Airlines, got it right. "If you want to be millionaire," he once said, "Start with a billion dollars and launch a new airline.” With my purchase in Hawaiian, I look forward to proving him wrong.