Egerton Capital is having a strong year. The fund has been outperforming equity markets while carrying a net long exposure of just 50%. It is a result of the fund’s alpha on both the long- and the short side in 2017. On the long side, the fund recently established a position in Alaska Airlines which according to John Armitage trades on an extremely attractive valuation of ‘high single digit’ multiples to 2018 estimated earnings.
Alaska Airlines is the 5th largest US airline which operates predominantly in the West Coast with 300 aircraft. Consolidation has had a very positive effect on the US airline industry. In 2007 the four largest airlines controlled 56% of US capacity and the industry generated 120bln of revenue, with an EBITDA margin of 13.6% and net debt averaging 1.5x EBITDA. In 2016 the top 4 airlines controlled 85% of capacity, industry revenues were 150bln, EBITDA margins were 24% and net debt averaged 0.7x EBITDA. The airline industry returned 14bln to shareholders in 2016. (it has returned more in the last two years to shareholders than in its entire history prior to this period.)
Alaska has performed extremely well against this very healthy backdrop. It has grown capacity by c. 7.5% per annum since 2009 (>double the industry) and consistently achieved industry-leading margins. The company’s business approach is to combine low costs with a very generous loyalty programme.
Alaska recently acquired Virgin America. Its network was, until now, based in the Pacific Northwest (PNW), but the Virgin deal has brought it a significant presence in California and a growth platform. Virgin’s gates at San Francisco and Los Angeles are valuable and under-utilized and Alaska will be able to add capacity at relatively low incremental cost, adding destinations and schedules to achieve PNW like relevance, initially from San Francisco and San Diego. Management also sees a huge opportunity in building its loyalty program into the Virgin customer base.
Virgin was very under-managed with a pre-tax margin of 14% (versus Alaska’s 24%) and Armitage believes that Alaska’s management will run it significantly better. Management is very confident of achieving the 300mln in targeted synergies. On that basis, the valuation is extremely attractive on a high single digit multiple of Egerton’s estimate of 2018 earnings and with significant further profits growth likely in 2019 and beyond.