ALGT - Allegiant Travel Company

[MrB]

Allegiant 10 yr financial track record per annum.

------Sales growth 15%

------Sales/share growth 18%

------ROE 30%

------AVG net margin 11%

------Low reliance on operating leases.

------Currently 53% Total debt/Total assets, but generally they run with lower debt.

 

In terms of financials there is really no other airline that comes close.

 

 

[walkie518]

Allegiant 10 yr financial track record per annum.

------Sales growth 15%

------Sales/share growth 18%

------ROE 30%

------AVG net margin 11%

------Low reliance on operating leases.

------Currently 53% Total debt/Total assets, but generally they run with lower debt.

 

In terms of financials there is really no other airline that comes close.

 

Agreed and it looks like you're not the only one that thinks the company will succeed!

 

https://www.sec.gov/Archives/edgar/data/1362468/000021545718005597/us01748x1028_050318.txt

 

[gfp]

You are comforted in your analysis because Blackrock has a position?  That's a lot like getting excited about finding Vanguard on the shareholder register...

[walkie518]

You are comforted in your analysis because Blackrock has a position?  That's a lot like getting excited about finding Vanguard on the shareholder register...

 

I don't have a position...just pointing out a recent filing for 10% ownership...

[walkie518]

pg 14

 

https://fpa.com/docs/default-source/investor-day/capital_investor-day-presentation-v-final_watermark.pdf?sfvrsn=2

[MrB]

Good piece on the ULLC market

https://thesis.eur.nl/pub/39727/Regt-T-de-453462-MA-thesis.pdf

[walkie518]

Thanks for posting that paper, it looks very interesting and perhaps provides another angle to the LCC/ULCC thesis.

 

Ever since the Southwest accident, metal fatigue has been on my mind. 

 

I would think regional carriers have more of a concern than say Delta or United.  The more time spent in high-stress, ie lift-off and landing, would result in greater probability of an incident resulting from metal fatigue.

 

The problem, of course, is that the FAA is behind the ball here, and it may be argued that the agency was at greater fault than GE/Safran or Southwest. 

 

Why? Previously, blades required visual inspection for metal fatigue, but a tiny crack may not be easy to spot...the solution is to use ultra-sound on each blade for higher definition than a visual inspection. 

 

What I wonder is when/if those costs translate into higher maintenance fees for low cost carriers or if GE/Safran will be required to eat the cost for current contracts then increase prices for new equipment and training requirements?

 

[walkie518]

this might be getting interesting at these levels again...anyone have a compelling short thesis to round out the positives?

[CLM5]

Haven't seen a short thesis, but it would contain the following:

 

- In a rising fuel price environment, which most people expect for the next few years, Allegiant will scale back capacity meaningfully. This makes the total ASMs/capacity forecasted by 2020 a large over-estimate. The capacity growth by 2020 is a big part of the bull thesis, as the fleet transition finishes and they continue to add to their A320 fleet.

 

Certainly, if fuel prices rise for the next few years, an investment in Allegiant now won't be very successful.

 

- Allegiant's business model has essentially no competition currently. From what I've seen in headlines recently, it looks like Spirit might be getting into some of the smaller cities that Allegiant currently exclusively serves. There is also a potential startup ULCC that could be focusing on smaller cities as well. I can't remember who the founder is, but it was one of the guys involved with a ULCC that was taken over in the last decade or so. Any competition in these small cities could be pretty devastating either to margins and/or capacity.

 

- For some reason, Maury Gallagher has decided that despite their current business model which has very attractive returns on capital and limited competition, he wants to branch out into the hotel/condo business.... could be a potential destruction of a huge amount of capital depending on how they work out the financing and the demand they see for the condos.

 

 

With all that being said, we're going to see a pretty mechanical drop in Cost/ASM over the next 3 years as the fleet transition finishes up, and they scale back all the extra staff/pilots, training for new aircraft, etc... If we assume they don't see any new entrants into their niche, and fuel prices stay the same or drop, this will have a pretty impressive return over the next 3-5 years. Realistically, no one knows what fuel prices are going to do, and they're cyclical anyways so I think the more important point to focus on is the quality of the business and the returns on incremental capital they see throughout an entire cycle.

[walkie518]

Haven't seen a short thesis, but it would contain the following:

 

- In a rising fuel price environment, which most people expect for the next few years, Allegiant will scale back capacity meaningfully. This makes the total ASMs/capacity forecasted by 2020 a large over-estimate. The capacity growth by 2020 is a big part of the bull thesis, as the fleet transition finishes and they continue to add to their A320 fleet.

 

Certainly, if fuel prices rise for the next few years, an investment in Allegiant now won't be very successful.

 

- Allegiant's business model has essentially no competition currently. From what I've seen in headlines recently, it looks like Spirit might be getting into some of the smaller cities that Allegiant currently exclusively serves. There is also a potential startup ULCC that could be focusing on smaller cities as well. I can't remember who the founder is, but it was one of the guys involved with a ULCC that was taken over in the last decade or so. Any competition in these small cities could be pretty devastating either to margins and/or capacity.

 

- For some reason, Maury Gallagher has decided that despite their current business model which has very attractive returns on capital and limited competition, he wants to branch out into the hotel/condo business.... could be a potential destruction of a huge amount of capital depending on how they work out the financing and the demand they see for the condos.

 

 

With all that being said, we're going to see a pretty mechanical drop in Cost/ASM over the next 3 years as the fleet transition finishes up, and they scale back all the extra staff/pilots, training for new aircraft, etc... If we assume they don't see any new entrants into their niche, and fuel prices stay the same or drop, this will have a pretty impressive return over the next 3-5 years. Realistically, no one knows what fuel prices are going to do, and they're cyclical anyways so I think the more important point to focus on is the quality of the business and the returns on incremental capital they see throughout an entire cycle.

after a quick glance, I couldn't find anything in the 10K, but they don't hedge fuel?

 

[CLM5]

 

after a quick glance, I couldn't find anything in the 10K, but they don't hedge fuel?

 

 

Correct, they do not hedge fuel. But the more important factor with fuel pricing isn't the rise in cost itself, it's the scaling back of the capacity. Because they have no competition in most of their routes and they offer extremely cheap pricing, their demand can swing pretty significantly with rising ticket prices due to rising fuel costs. This leads them to axing routes that are no longer attractive in that environment. 

 

E.g. - in today's fuel environment, say they're able to offer a 1 way ticket in a certain route for $60. For this route at this price, they see high load factors, and about 20% operating margin (which is what they target for individual routes). Now say fuel prices go up a dollar in the next year. There's still no competition on the route, but fuel prices alone have caused airfare to spike. Now, theoretically, they have to charge $90 for the same route to see that 20% operating margin. However, at $90, there isn't the same demand for the route so they're unable to achieve their operating margin. In this scenario, Allegiant just axes the route and focuses on the routes that they can achieve their target margin on.

 

This happens in a significant way in a rising fuel environment. They have to meaningfully scale back capacity to hit attractive returns. Obviously, the opposite happens in a falling fuel environment. They can add back in a bunch of routes that weren't attractive at the higher fuel price. 

 

This is in pretty stark contrast to every other airline. Allegiant is the only US-based airline that allocates flight paths like this to achieve their desired returns.

[walkie518]

 

after a quick glance, I couldn't find anything in the 10K, but they don't hedge fuel?

 

 

Correct, they do not hedge fuel. But the more important factor with fuel pricing isn't the rise in cost itself, it's the scaling back of the capacity. Because they have no competition in most of their routes and they offer extremely cheap pricing, their demand can swing pretty significantly with rising ticket prices due to rising fuel costs. This leads them to axing routes that are no longer attractive in that environment. 

 

E.g. - in today's fuel environment, say they're able to offer a 1 way ticket in a certain route for $60. For this route at this price, they see high load factors, and about 20% operating margin (which is what they target for individual routes). Now say fuel prices go up a dollar in the next year. There's still no competition on the route, but fuel prices alone have caused airfare to spike. Now, theoretically, they have to charge $90 for the same route to see that 20% operating margin. However, at $90, there isn't the same demand for the route so they're unable to achieve their operating margin. In this scenario, Allegiant just axes the route and focuses on the routes that they can achieve their target margin on.

 

This happens in a significant way in a rising fuel environment. They have to meaningfully scale back capacity to hit attractive returns. Obviously, the opposite happens in a falling fuel environment. They can add back in a bunch of routes that weren't attractive at the higher fuel price. 

 

This is in pretty stark contrast to every other airline. Allegiant is the only US-based airline that allocates flight paths like this to achieve their desired returns.

that's pretty interesting... I wonder if the hotel development is a way to make some extra money to offset the need to cancel routes that are not hitting targets?  as in this is a way to invest excess capital in exchange for stability, even if it reduces returns?

[CLM5]

 

that's pretty interesting... I wonder if the hotel development is a way to make some extra money to offset the need to cancel routes that are not hitting targets?  as in this is a way to invest excess capital in exchange for stability, even if it reduces returns?

 

I think that a least touches on a valid point. Obviously they won't come out directly and say it, but I think they branched out because they're hitting a limit on growth in their niche. Their business model is to connect small cities to vacation destinations, which has essentially zero competition. I think they're running out of routes, which is forcing them into medium sized cities - routes with much more competition. I think this real estate is their way to keep with the growth, but I definitely wouldn't call this excess capital. They're already pretty extended leverage-wise with this fleet upgrade. So yeah, in a sense, I think the hotel is a way to combat slowing capacity growth.

 

I think they're being far too optimistic and promotional with the real estate opportunity... but it undoubtedly should have at least SOME synergies with the airline. Still doesn't mean it was a good idea.

[MrB]

Really don't like what's happening on the resort side, but these are impressive numbers

https://seekingalpha.com/news/3395594-allegiant-reports-september-q3-traffic

[CLM5]

They look especially attractive after management sandbagged guidance which tanked the stock in the previous quarter.

[DTEJD1997]

Hey all:

 

Anybody else currently looking at ALGT?

 

They had a somewhat less than anticipated quarterly earnings report.

 

The stock is essentially at 52 week lows.

 

It would interesting to counter a position in ALGT with O&G equities.

 

Any thoughts/insights?

[BeerBBQ]

They look especially attractive after management sandbagged guidance which tanked the stock in the previous quarter.

 

What don't you like about it: funding/risk? not core business/loss of focus on core? something else?  The overall strategy seems to make sense on paper i.e. use airline to funnel vacationers to a resort where more of the vacationers wallet can be captured.  I realize on paper and execution are two vastly different things.  I'm sure you saw the presentation on sunseeker a few weeks ago.  The numbers, competitive position, etc. again on paper look interesting.  Did you see anything in there that gave you pause, you don't believe, was wrong etc.?

[walkie518]

Hey all:

 

Anybody else currently looking at ALGT?

 

They had a somewhat less than anticipated quarterly earnings report.

 

The stock is essentially at 52 week lows.

 

It would interesting to counter a position in ALGT with O&G equities.

 

Any thoughts/insights?

the real estate development activities don't make this as clean as another ultra low cost carrier or even a save or jblu...aal is possibly cleanest since aal doesn't hedge against oil

[CLM5]

They look especially attractive after management sandbagged guidance which tanked the stock in the previous quarter.

 

What don't you like about it: funding/risk? not core business/loss of focus on core? something else?  The overall strategy seems to make sense on paper i.e. use airline to funnel vacationers to a resort where more of the vacationers wallet can be captured.  I realize on paper and execution are two vastly different things.  I'm sure you saw the presentation on sunseeker a few weeks ago.  The numbers, competitive position, etc. again on paper look interesting.  Did you see anything in there that gave you pause, you don't believe, was wrong etc.?

 

I agree with you that it does make sense on paper. But there are a few things that give me pause:

 

- They initially said that the entire project would be de-risked, funded with non-recourse debt and owner deposits. Over time, they've walked those goals backwards. We're at a point now where the only plan in place is to entirely fund the project from operational cash flows. On one hand, it's extremely impressive that an airline would be able to fund a project like this out of cash flows. On the other hand, the entire project is now a risk to shareholders. They say the budget left for the project is $420mm, which is over 20% of the entire market cap of the business. I ask you, which would you prefer.... $420mm of share buybacks at these prices, $420mm of dividends, $420mm of fleet expansion into more Airbus A320s with proven good returns on capital, or a real estate development project outside management's core competency in an unproven area? I would prefer any of the above to the real estate.

 

The other point about the funding is if they could have funded the project without risk, they would have. This probably means, a) they struggled to get deposits on condos meaning the demand is not there, and b) they were unable to secure non-recourse debt for the project. Neither is a good sign.

 

- I think the most important point is that Maury has been extremely successful growing ALGT over the past 17 years. The business model is pretty incredible considering the industry they're in. The returns on capital are very high, especially for an airline. The returns on capital for their new A320 fleet is likely to be above 30% for each A320 (they cost on average $17mm per plane, and they see cash returns before interest and tax of >$5mm per plane. If you believe management, they'll see over $6mm per plane). Management SAYS that there's more room to grow into their niche - more small cities with zero competition as well as a huge opportunity in underserved mid-sized cities. If you believe that they have this huge market to still grow into, then why in the hell would they pivot to this huge real estate development project when they have such high returns on capital in their core competency? It certainly makes one think that the market opportunity isn't as big as they say it is (at least the portion in which they have no competition), and they may be nearing the end of growth in their niche.

 

- Lastly, they're doing this at a point in time where their balance sheet is more stretched than it's ever been. They just went through a fleet transition, leaving them with over $1B in debt to entirely replace their MD-80 fleet with A320s. I want to say they have about $900mm in obligations over the next 2 or 3 years, on top of that $420mm budget for the real estate project.

 

With that being said, EBITDA-post transition should be around $350-400mm this year, and upwards of $600mm within 3 years if managements goals are believed. I think worst case operations-wise, EBITDA is $500mm in 3 years. The transition is entirely completed as of now, and costs should inflect down/earnings should inflect upwards next year. This makes the debt less of a concern. However, further large increases in the price of oil and/or a huge downturn in the economy could cause some serious concern in them being able to meet their obligations, yet they're planning on funding a real estate project with cash flows rather than shoring up their balance sheet.

 

Also, ALGT doesn't hedge against oil either. Good in the long run, but with quick run-ups in oil prices like over the past year, it can be a bit painful. You can see from past results that yields take a bit to catch up with fuel prices, but ALGT can generally pass along their margin to customers as they don't really have competition in their niche. Even at the top of oil prices in the past decade, Allegiant maintained an impressive operating margin unlike pretty much any other US-based airline.

 

 

Edit: I should say.... despite all of the reasons the real estate is not appealing, I still own ALGT. I think the fleet transition is pretty deeply misunderstood by the market, and projections going forward seem far too low to me. On the airline side, we're going to see a pretty mechanical reduction of costs and increase in ASMs over the next 3 years that is just not being recognized by the market. And the real estate project likely won't have any material affect on the income statement for quite some time ( the same obviously can't be said of the balance sheet ). 

[MrB]

They look especially attractive after management sandbagged guidance which tanked the stock in the previous quarter.

 

What don't you like about it: funding/risk? not core business/loss of focus on core? something else?  The overall strategy seems to make sense on paper i.e. use airline to funnel vacationers to a resort where more of the vacationers wallet can be captured.  I realize on paper and execution are two vastly different things.  I'm sure you saw the presentation on sunseeker a few weeks ago.  The numbers, competitive position, etc. again on paper look interesting.  Did you see anything in there that gave you pause, you don't believe, was wrong etc.?

 

I agree with you that it does make sense on paper. But there are a few things that give me pause:

 

- They initially said that the entire project would be de-risked, funded with non-recourse debt and owner deposits. Over time, they've walked those goals backwards. We're at a point now where the only plan in place is to entirely fund the project from operational cash flows. On one hand, it's extremely impressive that an airline would be able to fund a project like this out of cash flows. On the other hand, the entire project is now a risk to shareholders. They say the budget left for the project is $420mm, which is over 20% of the entire market cap of the business. I ask you, which would you prefer.... $420mm of share buybacks at these prices, $420mm of dividends, $420mm of fleet expansion into more Airbus A320s with proven good returns on capital, or a real estate development project outside management's core competency in an unproven area? I would prefer any of the above to the real estate.

 

The other point about the funding is if they could have funded the project without risk, they would have. This probably means, a) they struggled to get deposits on condos meaning the demand is not there, and b) they were unable to secure non-recourse debt for the project. Neither is a good sign.

 

- I think the most important point is that Maury has been extremely successful growing ALGT over the past 17 years. The business model is pretty incredible considering the industry their in. The returns on capital are very high, especially for an airline. The returns on capital for their new A320 fleet is likely to be above 30% for each A320 (they cost on average $17mm per plane, and they see cash returns before interest and tax of >$5mm per plane. If you believe management, they'll see over $6mm per plane). Management SAYS that there's more room to grow into their niche - more small cities with zero competition as well as a huge opportunity in underserved mid-sized cities. If you believe that they have this huge market to still grow into, then why in the hell would they pivot to this huge real estate development project when they have such high returns on capital in their core competency? It certainly makes one think that the market opportunity isn't as big as they say it is (at least the portion in which they have no competition), and they may be nearing the end of growth in their niche.

 

- Lastly, they're doing this at a point in time where their balance sheet is more stretched than it's ever been. They just went through a fleet transition, leaving them with over $1B in debt to entirely replace their MD-80 fleet with A320s. I want to say they have about $900mm in obligations over the next 2 or 3 years, on top of that $420mm budget for the real estate project.

 

With that being said, EBITDA-post transition should be around $350-400mm this year, and upwards of $600mm within 3 years if managements goals are believed. I think worst case operations-wise, EBITDA is $500mm in 3 years. The transition is entirely completed as of now, and costs should inflect down/earnings should inflect upwards next year. This makes the debt less of a concern. However, further large increases in the price of oil and/or a huge downturn in the economy could cause some serious concern in them being able to meet their obligations, yet they're planning on funding a real estate project with cash flows rather than shoring up their balance sheet.

 

Also, ALGT doesn't hedge against oil either. Good in the long run, but with quick run-ups in oil prices like over the past year, it can be a bit painful. You can see from past results that yields take a bit to catch up with fuel prices, but ALGT can generally pass along their margin to customers as they don't really have competition in their niche. Even at the top of oil prices in the past decade, Allegiant maintained an impressive operating margin unlike pretty much any other US-based airline.

Couldn't agree more. Also what is interesting is the pace of change in the story. Over the space of a few quarters, it has moved from being a side project with shareholders funding land only to the airline supporting this massive hotel project.

The airline is one hell of a business, that's why we own it. However, I'm being dragged along kicken en screaming at this point!!

[MrB]

President John Redmond (their MGM real estate guy) purchased 12,000 shares, taking his stake up to 108,125

 

 

 

John Redmond

Director

 

 

John Redmond was originally elected to our board in 2007 and served until June 2013, when he resigned to assume a full-time commitment in Australia. After the completion of his commitment, he was once again designated to serve on the board in April 2014. He is an independent Director. From January 2013 until April 2014, Mr. Redmond served as managing director and chief executive officer of Echo Entertainment Group, Ltd., a gaming and hospitality company. From 2007 until January 2013, Mr. Redmond devoted his time to his private investments. Mr. Redmond served as president and chief executive officer of MGM Grand Resorts, LLC and a director of its parent company, MGM Mirage, from 2001 until 2007. Prior to that, he served as co-chief executive officer and a director of MGM Grand, Inc. from December 1999 to March 2001. He was senior vice president of MGM Grand Development, Inc. from 1996 to 1999. He served as vice-chairman of MGM Grand Detroit, LLC from 1998 to 2000 and chairman from 2000 until 2007. Prior to 1996, Mr. Redmond was senior vice president and chief financial officer of Caesars Palace and Sheraton Desert Inn, having served in various other senior operational and development positions with Caesars World, Inc. Mr. Redmond has served as a director of Vail Resorts, Inc. since 2008 and served as director of Tropicana Las Vegas Hotel and Casino, Inc. from 2009 until June 2013 and of Echo Entertainment Group Limited from September 2011 until April 2014.

[BeerBBQ]

They look especially attractive after management sandbagged guidance which tanked the stock in the previous quarter.

 

What don't you like about it: funding/risk? not core business/loss of focus on core? something else?  The overall strategy seems to make sense on paper i.e. use airline to funnel vacationers to a resort where more of the vacationers wallet can be captured.  I realize on paper and execution are two vastly different things.  I'm sure you saw the presentation on sunseeker a few weeks ago.  The numbers, competitive position, etc. again on paper look interesting.  Did you see anything in there that gave you pause, you don't believe, was wrong etc.?

 

I agree with you that it does make sense on paper. But there are a few things that give me pause:

 

- They initially said that the entire project would be de-risked, funded with non-recourse debt and owner deposits. Over time, they've walked those goals backwards. We're at a point now where the only plan in place is to entirely fund the project from operational cash flows. On one hand, it's extremely impressive that an airline would be able to fund a project like this out of cash flows. On the other hand, the entire project is now a risk to shareholders. They say the budget left for the project is $420mm, which is over 20% of the entire market cap of the business. I ask you, which would you prefer.... $420mm of share buybacks at these prices, $420mm of dividends, $420mm of fleet expansion into more Airbus A320s with proven good returns on capital, or a real estate development project outside management's core competency in an unproven area? I would prefer any of the above to the real estate.

 

The other point about the funding is if they could have funded the project without risk, they would have. This probably means, a) they struggled to get deposits on condos meaning the demand is not there, and b) they were unable to secure non-recourse debt for the project. Neither is a good sign.

 

- I think the most important point is that Maury has been extremely successful growing ALGT over the past 17 years. The business model is pretty incredible considering the industry they're in. The returns on capital are very high, especially for an airline. The returns on capital for their new A320 fleet is likely to be above 30% for each A320 (they cost on average $17mm per plane, and they see cash returns before interest and tax of >$5mm per plane. If you believe management, they'll see over $6mm per plane). Management SAYS that there's more room to grow into their niche - more small cities with zero competition as well as a huge opportunity in underserved mid-sized cities. If you believe that they have this huge market to still grow into, then why in the hell would they pivot to this huge real estate development project when they have such high returns on capital in their core competency? It certainly makes one think that the market opportunity isn't as big as they say it is (at least the portion in which they have no competition), and they may be nearing the end of growth in their niche.

 

- Lastly, they're doing this at a point in time where their balance sheet is more stretched than it's ever been. They just went through a fleet transition, leaving them with over $1B in debt to entirely replace their MD-80 fleet with A320s. I want to say they have about $900mm in obligations over the next 2 or 3 years, on top of that $420mm budget for the real estate project.

 

With that being said, EBITDA-post transition should be around $350-400mm this year, and upwards of $600mm within 3 years if managements goals are believed. I think worst case operations-wise, EBITDA is $500mm in 3 years. The transition is entirely completed as of now, and costs should inflect down/earnings should inflect upwards next year. This makes the debt less of a concern. However, further large increases in the price of oil and/or a huge downturn in the economy could cause some serious concern in them being able to meet their obligations, yet they're planning on funding a real estate project with cash flows rather than shoring up their balance sheet.

 

Also, ALGT doesn't hedge against oil either. Good in the long run, but with quick run-ups in oil prices like over the past year, it can be a bit painful. You can see from past results that yields take a bit to catch up with fuel prices, but ALGT can generally pass along their margin to customers as they don't really have competition in their niche. Even at the top of oil prices in the past decade, Allegiant maintained an impressive operating margin unlike pretty much any other US-based airline.

 

 

Edit: I should say.... despite all of the reasons the real estate is not appealing, I still own ALGT. I think the fleet transition is pretty deeply misunderstood by the market, and projections going forward seem far too low to me. On the airline side, we're going to see a pretty mechanical reduction of costs and increase in ASMs over the next 3 years that is just not being recognized by the market. And the real estate project likely won't have any material affect on the income statement for quite some time ( the same obviously can't be said of the balance sheet ).

 

Thanks for the detailed comments.  Very Helpful!     

[walkie518]

They look especially attractive after management sandbagged guidance which tanked the stock in the previous quarter.

 

What don't you like about it: funding/risk? not core business/loss of focus on core? something else?  The overall strategy seems to make sense on paper i.e. use airline to funnel vacationers to a resort where more of the vacationers wallet can be captured.  I realize on paper and execution are two vastly different things.  I'm sure you saw the presentation on sunseeker a few weeks ago.  The numbers, competitive position, etc. again on paper look interesting.  Did you see anything in there that gave you pause, you don't believe, was wrong etc.?

 

I agree with you that it does make sense on paper. But there are a few things that give me pause:

 

- They initially said that the entire project would be de-risked, funded with non-recourse debt and owner deposits. Over time, they've walked those goals backwards. We're at a point now where the only plan in place is to entirely fund the project from operational cash flows. On one hand, it's extremely impressive that an airline would be able to fund a project like this out of cash flows. On the other hand, the entire project is now a risk to shareholders. They say the budget left for the project is $420mm, which is over 20% of the entire market cap of the business. I ask you, which would you prefer.... $420mm of share buybacks at these prices, $420mm of dividends, $420mm of fleet expansion into more Airbus A320s with proven good returns on capital, or a real estate development project outside management's core competency in an unproven area? I would prefer any of the above to the real estate.

 

The other point about the funding is if they could have funded the project without risk, they would have. This probably means, a) they struggled to get deposits on condos meaning the demand is not there, and b) they were unable to secure non-recourse debt for the project. Neither is a good sign.

 

- I think the most important point is that Maury has been extremely successful growing ALGT over the past 17 years. The business model is pretty incredible considering the industry they're in. The returns on capital are very high, especially for an airline. The returns on capital for their new A320 fleet is likely to be above 30% for each A320 (they cost on average $17mm per plane, and they see cash returns before interest and tax of >$5mm per plane. If you believe management, they'll see over $6mm per plane). Management SAYS that there's more room to grow into their niche - more small cities with zero competition as well as a huge opportunity in underserved mid-sized cities. If you believe that they have this huge market to still grow into, then why in the hell would they pivot to this huge real estate development project when they have such high returns on capital in their core competency? It certainly makes one think that the market opportunity isn't as big as they say it is (at least the portion in which they have no competition), and they may be nearing the end of growth in their niche.

 

- Lastly, they're doing this at a point in time where their balance sheet is more stretched than it's ever been. They just went through a fleet transition, leaving them with over $1B in debt to entirely replace their MD-80 fleet with A320s. I want to say they have about $900mm in obligations over the next 2 or 3 years, on top of that $420mm budget for the real estate project.

 

With that being said, EBITDA-post transition should be around $350-400mm this year, and upwards of $600mm within 3 years if managements goals are believed. I think worst case operations-wise, EBITDA is $500mm in 3 years. The transition is entirely completed as of now, and costs should inflect down/earnings should inflect upwards next year. This makes the debt less of a concern. However, further large increases in the price of oil and/or a huge downturn in the economy could cause some serious concern in them being able to meet their obligations, yet they're planning on funding a real estate project with cash flows rather than shoring up their balance sheet.

 

Also, ALGT doesn't hedge against oil either. Good in the long run, but with quick run-ups in oil prices like over the past year, it can be a bit painful. You can see from past results that yields take a bit to catch up with fuel prices, but ALGT can generally pass along their margin to customers as they don't really have competition in their niche. Even at the top of oil prices in the past decade, Allegiant maintained an impressive operating margin unlike pretty much any other US-based airline.

 

 

Edit: I should say.... despite all of the reasons the real estate is not appealing, I still own ALGT. I think the fleet transition is pretty deeply misunderstood by the market, and projections going forward seem far too low to me. On the airline side, we're going to see a pretty mechanical reduction of costs and increase in ASMs over the next 3 years that is just not being recognized by the market. And the real estate project likely won't have any material affect on the income statement for quite some time ( the same obviously can't be said of the balance sheet ).

 

Thanks for the detailed comments.  Very Helpful!   

While I don't necessarily disagree, I would note that construction loans tend to be a multiple more expensive than mortgages on stabilized properties.  Moreover, the kinds of lenders willing to do construction loans at this size and in this area are likely somewhat limited. 

 

Moreover, while ultimate build costs tend to be what they are, in many new builds, total cost is deferred by phase.  In a way, because payments are scheduled, there is a form of "built-in" financing before working with a lender.  And in the case where a firm uses a lender, there is additional red-tape regarding how and when checks get cut.  This can put strain on the builder as well as the sponsor, especially in a lesser developed area. 

 

Also, companies that build and keep risk on the balance sheet tend to be better businesses than companies seeking to de-risk at every stage.  Non-recourse loans shouldn't be thought of as lender's risk only...if the sponsor has no interest in making the project work, the lender will shy away.  If it's the first of its kind, a lender will want some kind of backup...what I imply is that you have to put your feet in the shoes of the lender given the circumstances. 

 

And last point on this topic, I would note that a loan against a stabilized asset could be non-recourse and cost the company half the interest expense.  This provides a liquidity windfall for further development if needed to create a necessary center of mass.

 

There will certainly be additional costs down the line to market, not borrowing and using cash flows as available might be the cheapest and most flexible way to get it all done. 

[CLM5]

 

While I don't necessarily disagree, I would note that construction loans tend to be a multiple more expensive than mortgages on stabilized properties.  Moreover, the kinds of lenders willing to do construction loans at this size and in this area are likely somewhat limited. 

 

Moreover, while ultimate build costs tend to be what they are, in many new builds, total cost is deferred by phase.  In a way, because payments are scheduled, there is a form of "built-in" financing before working with a lender.  And in the case where a firm uses a lender, there is additional red-tape regarding how and when checks get cut.  This can put strain on the builder as well as the sponsor, especially in a lesser developed area. 

 

Also, companies that build and keep risk on the balance sheet tend to be better businesses than companies seeking to de-risk at every stage.  Non-recourse loans shouldn't be thought of as lender's risk only...if the sponsor has no interest in making the project work, the lender will shy away.  If it's the first of its kind, a lender will want some kind of backup...what I imply is that you have to put your feet in the shoes of the lender given the circumstances. 

 

And last point on this topic, I would note that a loan against a stabilized asset could be non-recourse and cost the company half the interest expense.  This provides a liquidity windfall for further development if needed to create a necessary center of mass.

 

There will certainly be additional costs down the line to market, not borrowing and using cash flows as available might be the cheapest and most flexible way to get it all done.

 

I agree with everything you said. Using cash flows is definitely the cheapest and most flexible way to get it done, and they definitely have the cash flows to do it. And you're probably right that them choosing this route doesn't necessarily mean anything negative. But that doesn't change the fact that, as a shareholder, this is the option that has the largest potential downside and it's immediately felt on the balance sheet. I would much prefer no real estate development project at all to a real estate development project financed via cash flows which could have been used for a number of other things with proven returns...

 

Edit: After thinking about it a little more, the one thing we failed to touch on would be using customer deposits to fund the permanent living facilities of the project. I don't recall them mentioning anything on this line, but if they were unable to secure any of this type of funding, that's a pretty big bummer. This would have been a free float that would have significantly reduced their cost of capital for the project. Landing this type of funding for any real estate development project is a huge advantage. I don't know if they didn't see any demand or what (which could potentially have negative implications), but I haven't seen it mentioned since their initial plans.

[MrB]

Strong numbers from the airline. Still don't understand why they get involved in all these ancillary businesses. Great numbers though

http://ir.allegiantair.com/news-releases/news-release-details/allegiant-travel-company-second-quarter-2019-financial-results