Allegiant - An Airline/Resort
01-18-2019, 06:58 AM
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Allegiant - An Airline/Resort
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Allegiant Travel: Low Cost Airline Plus Resort Development?
Jan. 18, 2019 10:20 AM•ALGT
Allegiant is a niche airline with a defensible competitive position and good growth.
This model will likely last another 3-5 years when it will run into competitive difficulties that will limit additional expansion.
That’s why it’s attempting an extension into the leisure travel industry with a resort development in Florida.
Such strategic shifts are rarely a good sign,but the upside and downside seem likely to have little initial impact on Allegiant’s value.
Introduction
Usually, when a business that’s had success in its market niche decides to allocate capital to a totally new strategy, you should run, not walk, for the exit. It almost always signals bad news for the old niche, and a management team desperate to keep their empire growing regardless of what it does to business value or shareholders. With that in mind, my initial look at Allegiant (ALGT) made me cringe. It’s a very successful airline (almost an oxymoron) that’s carved out a narrow part of the industry with a unique business model, and has generated tremendous value for its shareholders over the last 12+ years.
But, in 2016 Allegiant hired a new president from the gaming/hospitality industry and is now investing in a resort in Florida dubbed: Sunseeker. Really? I must admit, I’m not sold on the idea, but I think the market isn’t giving credit to Allegiant for still being a growing airline, at least for a few more years, and perhaps over-estimating the damage of Sunseeker and maybe even giving insufficient credit to a management team with an impressive track record. Not sold? Well, read on.
To take apart Allegiant, I think it’s best to break the business into its two parts: the airline business that’s its legacy, and the resort business which is a part of its potential future.
Allegiant Travel, the airline
As mentioned above, Allegiant has managed to exploit a unique niche in the airline industry. Instead of buying new aircraft and focusing on high utilization (like almost all other airlines), it buys used aircraft and focuses on a cost driven schedule. That means it only flies routes where it can justify the costs. This is a low frequency model based on weekly instead of multiple daily flights. Rather than maximizing capacity flying at multiple times into and out of busy large cities, it maximizes capacity by flying into and out of small and mid-sized cities once, twice, three times a week. This gives it flexibility in scheduling capacity, and allows it to profit on much lower volumes. As proof, 75% of Allegiant’s approximately 350 routes don’t have direct competitors. Also, small and mid-sized cities are less costly to serve because they have significantly lower station fees.
Used aircraft is an important part of Allegiant’s model. Used airframes are lower cost to buy, higher cost to maintain, but overall a lower cost structure that allows Allegiant to fly a low frequency, capacity managed business. It operates a single aircraft fleet to keep low costs for training and maintenance (they’ve transitioned from old MD80’s to newer, but still mostly used, A320’s—more on this below), just like Southwest and Ryanair. It focuses on labor management to keep expenses down with automation and part timers. Allegiant doesn’t hedge fuel costs having found that it costs too much and tends to help too little when fuel prices go up and hurt too much when they’re going down. Instead, it manages capacity down when fuel prices rise—something a used aircraft fleet allows.
Allegiant claims to have one of only two reservation systems built and owned fully by an airline, lowering costs and allowing for higher data control and future marketing opportunities. To keep marketing costs low, it focuses on direct sales for distribution: 94% of its sales are direct internet or phone. Allegiant is a true Ultra Low Cost Carrier (ULCC), meaning it charges a rock-bottom fee for airfare and then charges for every additional item: seat assignment, priority boarding, cancellations, food and beverage service, pet in the cabin, call center booking, boarding pass printing, carry-on bag, checked bag, overweight bag, oversize bag—yes, everything. They also make money on ancillary fees like hotel, rental car, vacation packages, etc. This point shouldn’t go overlooked. The airfare Allegiant charges, much like Ryanair in Europe, is just above or below cost, so they make almost all their profit on so-called ancillaries. This may seem like a crazy business model, until you look at the returns on capital of Allegiant or Ryanair (RYAAY). It works.
Allegiant is targeting 10% growth over the next 3-5 years, and expects to hit that target by expanding into 1-2 new mid-sized cities per year (mid-sized cities are more expensive than small cities, and more likely to encounter competitive air carriers; Allegiant has made the model work…so far). Keep in mind underlying passenger growth in the U.S. is expected to be 1.5-2.5% over the long term, so that means 7.5-8.5% additional growth beyond baseline, which is doable going into cities with limited airline service. Its financial model is low debt and high cash, unusual for an airline, although their debt has spiked over the last several years on swapping its fleet to A320s. Additional debt is likely to be raised for its resort expansion described below, too. Allegiant expects its costs to increase slower than revenue increases, allowing for margin expansion—operating leverage. Although, it has a track record of doing this successfully, I’m expecting this to be challenging going forward, but that would be upside if I’m wrong. Fuel and employee pay are its biggest expenses by far. Fuel is hard to control (they manage this through capacity changes), and employee pay is likely to go up as experienced pilot shortages are impacting the industry. Cost controls are a key cultural and business model advantage for Allegiant, but also what they must watch like a hawk to maintain the model successfully.
Allegiant, like all ULCCs, faces complaints about all its additional fees and lack of legroom, but the reality is that most leisure travelers want cheap airfares more than frills (a tendency Ryanair has exploited to the max). Many complain about Allegiant’s lack of amenities, but the numbers show that people keep coming back for the low fares. Put plainly, Allegiant’s consumers care more about transportation from remote destinations to sunny locations.
Airline Competition
Spirit (SAVE) is a high frequency airline with the newest fleet of A320’s out there. Southwest overlaps with 62% with its routes and American: 51%. Spirit focuses on leisure passengers with Fort Lauderdale, the Caribbean and Latin America as big destinations. 25% of its routes are greater than one flight per day, 50-60% are 1 flight per day and less than 15% are less than daily. It flies 1/3 big city, 1/3 leisure and 1/3 international, with expansion plans focused on international through Florida as a connection. This model is closer to Allegiant’s, and certainly has some overlap, but also distinctly different, especially with newer aircraft, higher frequency, and international destinations. As a remote possibility—and this is pure speculation—I could see Spirit buying Allegiant to bolster its service to and through Florida. With matching fleet type (but not age) and a big focus on Florida, acquisition seems more likely to me than Spirit deciding to go head-to-head with a low frequency model into small/mid-sized cities.
Next is Frontier Airlines, which is closest to Allegiant in enplaned passengers, but again quite different otherwise. Like Allegiant, they operate A320s, but they have one of the newest fleets. They operate mostly out of bigger cities: Denver, Atlanta, Chicago, Philadelphia, Las Vegas, Orlando, San Antonio, Raleigh, Cincinnati, Cleveland, Austin. They have around 300 routes to approximately 80 cities, some routes into the small cities Allegiant serves. In some ways you can see overlap: A320s and a few small and mid-sized cities, but in other ways not: new aircraft, mostly major cities, greater frequency. They provide some competition, but it looks like Frontier is pursuing a different strategy, at least for now (it’s owned by a private equity firm that could change the model if they believe they can make more money on it).
Sun Country is only 1/6 the size of Allegiant in terms of passengers, but has hired two ex-Allegiant executives and is trying to rescue a troubled business (Sun Country is also owned by a private equity firm). It operates around 70 routes, operates a fleet of around 30 737s that are new to 18 years old (average age around 14 years). It operates out of Minneapolis and serves around 45 destinations including Dallas, Fort Myers, the west coast, the Caribbean, Latin America. So far, it’s a different model, but that could change if they think they can gain on Allegiant. The key question is what would Allegiant’s response be, and could Sun Country weather that storm? Such a fight would reduce Allegiant’s margins, no doubt, and there would be little gained for either side, so that doesn’t seem like an imminent threat.
A new entrant is, I believe, the biggest competitive threat to Allegiant’s airline business. I think Allegiant operates at very low cost and would defend its small markets vigorously. So a competitor—whether large or small—would have to be well-funded and able to tolerate a lot of pain to win market share, and such a challenger would have to be convinced such an effort would be worthwhile relative to its scale and return expectations. More specifically, I think more than one competitor operating in those small markets would make it unprofitable for everyone, too, which makes such a proposition seem difficult. It’s not impossible, and bears close watching, but doesn’t seem like a looming threat for now.
Allegiant Travel, resort development
So, why on earth would a growing niche airline with good competitive positioning consider getting into resort development? The answer lies in the question: a growing niche airline won’t remain niche forever. Allegiant realizes its growth is limited: if it keeps growing into mid-sized cities, it will eventually grow into its competitors, who will want to compel Allegiant to play their game. Allegiant’s management recognizes this, and I think that’s why they are considering new business avenues and opportunities, which brings us to Sunseeker.
Put bluntly, Allegiant doesn’t want to just keep adding airplanes forever, moving further into competition with bigger rivals. So how best to allocate capital given its model of low cost/low frequency travel for leisure travelers to sunny destinations? The answer: exploit Florida traffic. Almost 50% of Allegiant’s customers already fly to Florida. Those customers spend 5-10% of their vacation budget on airfare, and someone else gets the other 90-95%. Why not try to take a piece of that pie? Allegiant has experienced very strong growth in Florida travel, and visitors make long stays to the state. Air traffic is currently out-pacing hotel growth, too, at least where Allegiant is looking to build a resort. It has great data from its airline business, and believes it can disrupt the travel industry by leveraging its Midwest customers’ desire to visit sunny Florida. The plan is to market to Allegiant’s current and potential customers. Remember, it makes most of its money on ancillary fees, not airfare, per se. Why not expand the ancillary fee that’s more profitable instead of the airfare that’s less so?
The overall approach is to sell direct to Allegiant’s customers, just like the airline. Instead of passing its customers off to other hotels and resorts, market them on Allegiant’s own resort: Sunseeker. Allegiant’s customers skew affluent, and it believes it only needs one out of 30 to one out of 15 of those customers who are flying to Florida, and in particular its Punta Gorda destination, and it can fill the resort. Why Punta Gorda? Not only is it a big Allegiant airport, with 80% of the airport’s traffic due to Allegiant, but there’s little resort/hotel competition in the area. Southwest Florida is underserved. There is less development there, and the inventory is old. On average, the hotels/resorts are 26 years old. Less than 10% were built post 2010. There are only around eight large resorts in the area, with an average age of 37 years. There are also few high end or unique food and beverage options available. Looking at the data, Allegiant thinks it can get 90+% occupancy, because the best product gets the best occupancy rates and that’s what it is planning to build. Its research into Airbnb and others shows this to be the case. It’s targeting a luxury to upper scale market, with $185+ hotel and $360+ condo rates per night.
Allegiant bought 22 acres on the sly (the president, who has hospitality/gaming experience, saw the potential and acted boldly), and are currently developing seven of those acres. It’s cheap waterfront, not beachfront, property. Allegiant has a $420 million budget, $125 million of which will come from the airline business, and expect to build a 500 room hotel as well as condo towers with around 190 suites. They have plans for a marina, restaurants and bars. They’ve even acquired a golf course. The location is just a short drive from the Punta Gorda airport, giving Allegiant steady access to customers (current and potential) flying there. The project is cheap by design (no carpets, easy to clean/maintain, direct marketing, etc.), which is what you’d expect from Allegiant. With its low-cost focus, it expects EBITDA margins of 38-40% (assuming 90+% occupancy). Allegiant is planning meeting spaces, too, to mitigate occupancy and day rate risk, with advanced bookings that will smooth out seasonality. September is a slow month in Florida, and a great time for meeting spaces and rooms to be filled. Too, this dovetails nicely into packaging and convention opportunities. Allegiant also sees management and franchise opportunities. This is a business Allegiant has long been involved with because of their 3rd party selling of hotels to customers. It foresees such a franchise/management business giving a small boost to revenue but a big boost to profits, as other hotel and resort franchisers like Hyatt, Hilton and Marriot can attest to. It will also allow them to play the revenue management game with distribution partners. An airline business is no stranger to the revenue management game. As mentioned above, Allegiant’s president came from the hotel and casino business (spending most of his time operating in Vegas), and he’s brought in seasoned managers to build and operate the resort. It has already hired an operator from MGM’s hotel business, an experienced builder with an excellent record, and a proven restaurant and bar expert—also from Vegas. This doesn’t appear to be a B-team of newbies, but experienced managers who know what they’re doing.
If you’re really interested in understanding Sunseeker, the strategic reasoning behind it, and what the management team at Sunseeker will look like, I recommend listening to Allegiant’s investor day presentation.
Do I think Sunseeker is a slam dunk? Definitely not. I have yet to read about an airline successfully entering the resort business (if anyone has, please let me know!). Just because it hasn’t been done doesn’t mean it can’t be done, but the burden of proof is definitely on Allegiant. The market isn’t just not giving them credit, they are assuming both the airline and resort business will flop judging by its stock price decline. In many ways, I don’t blame them. A greenfield resort like this would be difficult to pull off for anyone, but for an airline to try it seems almost rash. It’s true, Allegiant has the benefit of customers already coming to the market on its planes, and a lot of experience selling 3rd party services like hotels and rental cars and even vacation packages. It also has an extensive database of information about those customers and what they do when they come to Florida generally and Punta Gorda specifically. But, Allegiant must get a sufficient return on investment to justify this strategy change, and that’s a tall order considering the returns on its legacy business. The question for me, as a value investor, isn’t just can the project succeed, but at what price does the business discount too much the threat of Sunseeker? I’ll tackle that after I first review management, next.
Management
The president of Allegiant, John Redmond, is former president and CEO of MGM Grand Resorts, with more than 30 years of experience in the hospitality and leisure travel industry. In between MGM and Allegiant, he was the CEO of Echo Entertainment Group, a casino operator based in Australia. He’d been on the board of directors of Allegiant from 2007-2013 when he resigned to work in Australia, but then rejoined Allegiant’s board in 2014, from where he became president in 2016. Why did Maurice Gallagher bring a hospitality/gaming guy into an airline business? I don’t fully grasp the answer, but it seems that he foresaw more than 2 ½ years ago that growing the airline forevermore wasn’t a lasting strategy. It’s too early to say whether Gallagher and Redmond are geniuses, simply over-confident, or straight-up poor capital allocators. Time will tell.
Allegiant’s board of directors includes four former airline executives. That’s excellent experience for helping run an airline, but it begs the question of who on the board has the expertise to oversee a resort development business. I don’t have an answer, and that’s a concern. I would be much more comfortable with Allegiant as an investment if there were someone on the board pushing back on the resort strategy, someone with hospitality experience and preferably with a significant stake in Allegiant who was more worried about the growth of their investment than ruffling the feathers of executives and other board members. I can dream, can’t I.
Valuation
What about Sunseeker? I tried to model the business as best I could given the information Allegiant provides and some estimates of my own. I gave Sunseeker a 20% chance of weak, 80%, occupancy, which would decrease eps by $0.27 per share. I used a 25% probability of performing below expectations, 85% occupancy, which would reduce eps by $0.08 per share. If Sunseeker achieves low end expectations of 90% occupancy (Allegiant’s year 1 expectation), which I give a 40% chance, then I see $0.13 additional eps. If Sunseeker achieves 92% occupancy (Allegiant’s year 2 expectation), which I gave a 10% probability, then an additional $0.30 in eps would be made. And, if Sunseeker does well, which I gave a 5% chance with 96% occupancy (Allegiant’s year 5 expectation), then an additional $0.55 of eps would hit the bottom line. As you can see by my eps estimate levels, I don’t see Sunseeker moving the meter much. Sunseeker could do much worse or better than I’m modeling, but this framework gives you a flavor for how Sunseeker seems likely to impact Allegiant Travel as a whole. It could contribute 4% to 7% of additional revenue, and subtract 2% to add 4.5% to net income. It would, however, have a bigger impact on EBITDA. Allegiant plans to fund $125 million of the $420 million project, so debt becomes a bigger player—typical in real estate development and operations. Although it would tend to detract from net income with lower margins, it could contribute to EBITDA with higher margins than Allegiant’s airline business.
Risks
Allegiant’s business model is not without risks. First, there are perils to the top-line, which could impact units, pricing and ancillary fees with declines. Competition, especially new entrants, would threaten revenues, as would a recession, depression, or other economic calamity.
Second are risks to costs. Fuel and pay are the biggest threats, there. Fuel prices going up would compel Allegiant to cut capacity, which would result in lower revenues and worse unit economics, I believe. Lower fuel prices, too, could be an issue if it leads to capacity increases for the industry and makes it profitable for competitors to challenge those low frequency routes. Pay seems likely to be an issue going forward with experienced pilot shortages in the works. I think this can already be seen in Allegiant’s costs, and is likely to get worse before it gets better. From there, additional cost risks come from station expenses at those small and mid-sized origins as well as destination cities, higher depreciation and amortization costs from newer and more expensive aircraft, maintenance costs, selling and marketing expenses, and any other cost.
Additional risks include a plane crash, which isn’t hugely likely but not impossible, either (Boeing, Airbus’s competitor, calculated that A320s crash every 7 million flights, airsafe.com says 0.11 fatal crashes million flights). A crash would impose higher costs and lower revenues for some period. Information technology security is always a risk, too, and that risk is growing both in probability and impact on revenue and costs. FAA restrictions both on maintenance and air traffic are another threat. Allegiant tends to issue guidance to Wall Street, which is another short term risk to the stock price, because Wall Street really doesn’t like it when expectations aren’t met, and expectations not being met is as certain to happen in the fullness of time as the sun rising tomorrow morning. Executive departures have been another concern with Allegiant. It seems like many young executives make their name at Allegiant and then move on. After following up on eight departures over the last decade, I didn’t perceive any pattern, but one might assume that Gallagher is too cheap to pay a high price for talent, and so they move on. I can’t blame them, but low costs are the nature of Allegiant’s business, so I would tend to side with Gallagher unless he found someone truly indispensable, in which case I think he’d pay up.
The last big risk I want to address is the Sunseeker resort. This is a major strategy change, and thus a significant risk to the current and future business model. Will they generate the returns they expect? Will competitors drive down room rates and occupancy? Will this distract executives from running the airline? Will airline competitors use the resort distraction as an opportunity to compete on small and mid-sized city routes? Does the board have the chops to oversee a real estate project (not so far…)? I wouldn’t say Sunseeker is Allegiant’s biggest risk, which is clearly fuel and pay costs, but it ranks number three for me and could potentially become number one depending on how events unfold.
Conclusion
Allegiant is a highly efficient airline with a niche business model and very few competitors in its space. Its model isn’t dead, yet, having several more years of growth before running into competitive limits. Allegiant is branching out from being purely a cheap airline operating used aircraft to small and mid-sized cities in a new direction: resort development. There are some intriguing characteristics about this opportunity, including targeted customers already served by Allegiant in a destination with few strong competitors, but there are also big risks in that resort development and airline operations are very different businesses, and Allegiant has no track record as a resort developer. The management team at Allegiant includes a very experienced airline CEO and an experienced hospitality/gaming president. Both have good records of capital allocation and operational execution, so they can’t be written off out of hand. The valuation at Allegiant looks very interesting despite several risks and threats that must be weighed carefully. I think it will be very interesting to see how Allegiant grows and how its resort project comes off. Who knows, it might even make a strong investment.
Allegiant Travel: Low Cost Airline Plus Resort Development?
Jan. 18, 2019 10:20 AM•ALGT
Allegiant is a niche airline with a defensible competitive position and good growth.
This model will likely last another 3-5 years when it will run into competitive difficulties that will limit additional expansion.
That’s why it’s attempting an extension into the leisure travel industry with a resort development in Florida.
Such strategic shifts are rarely a good sign,but the upside and downside seem likely to have little initial impact on Allegiant’s value.
Introduction
Usually, when a business that’s had success in its market niche decides to allocate capital to a totally new strategy, you should run, not walk, for the exit. It almost always signals bad news for the old niche, and a management team desperate to keep their empire growing regardless of what it does to business value or shareholders. With that in mind, my initial look at Allegiant (ALGT) made me cringe. It’s a very successful airline (almost an oxymoron) that’s carved out a narrow part of the industry with a unique business model, and has generated tremendous value for its shareholders over the last 12+ years.
But, in 2016 Allegiant hired a new president from the gaming/hospitality industry and is now investing in a resort in Florida dubbed: Sunseeker. Really? I must admit, I’m not sold on the idea, but I think the market isn’t giving credit to Allegiant for still being a growing airline, at least for a few more years, and perhaps over-estimating the damage of Sunseeker and maybe even giving insufficient credit to a management team with an impressive track record. Not sold? Well, read on.
To take apart Allegiant, I think it’s best to break the business into its two parts: the airline business that’s its legacy, and the resort business which is a part of its potential future.
Allegiant Travel, the airline
As mentioned above, Allegiant has managed to exploit a unique niche in the airline industry. Instead of buying new aircraft and focusing on high utilization (like almost all other airlines), it buys used aircraft and focuses on a cost driven schedule. That means it only flies routes where it can justify the costs. This is a low frequency model based on weekly instead of multiple daily flights. Rather than maximizing capacity flying at multiple times into and out of busy large cities, it maximizes capacity by flying into and out of small and mid-sized cities once, twice, three times a week. This gives it flexibility in scheduling capacity, and allows it to profit on much lower volumes. As proof, 75% of Allegiant’s approximately 350 routes don’t have direct competitors. Also, small and mid-sized cities are less costly to serve because they have significantly lower station fees.
Used aircraft is an important part of Allegiant’s model. Used airframes are lower cost to buy, higher cost to maintain, but overall a lower cost structure that allows Allegiant to fly a low frequency, capacity managed business. It operates a single aircraft fleet to keep low costs for training and maintenance (they’ve transitioned from old MD80’s to newer, but still mostly used, A320’s—more on this below), just like Southwest and Ryanair. It focuses on labor management to keep expenses down with automation and part timers. Allegiant doesn’t hedge fuel costs having found that it costs too much and tends to help too little when fuel prices go up and hurt too much when they’re going down. Instead, it manages capacity down when fuel prices rise—something a used aircraft fleet allows.
Allegiant claims to have one of only two reservation systems built and owned fully by an airline, lowering costs and allowing for higher data control and future marketing opportunities. To keep marketing costs low, it focuses on direct sales for distribution: 94% of its sales are direct internet or phone. Allegiant is a true Ultra Low Cost Carrier (ULCC), meaning it charges a rock-bottom fee for airfare and then charges for every additional item: seat assignment, priority boarding, cancellations, food and beverage service, pet in the cabin, call center booking, boarding pass printing, carry-on bag, checked bag, overweight bag, oversize bag—yes, everything. They also make money on ancillary fees like hotel, rental car, vacation packages, etc. This point shouldn’t go overlooked. The airfare Allegiant charges, much like Ryanair in Europe, is just above or below cost, so they make almost all their profit on so-called ancillaries. This may seem like a crazy business model, until you look at the returns on capital of Allegiant or Ryanair (RYAAY). It works.
Allegiant is targeting 10% growth over the next 3-5 years, and expects to hit that target by expanding into 1-2 new mid-sized cities per year (mid-sized cities are more expensive than small cities, and more likely to encounter competitive air carriers; Allegiant has made the model work…so far). Keep in mind underlying passenger growth in the U.S. is expected to be 1.5-2.5% over the long term, so that means 7.5-8.5% additional growth beyond baseline, which is doable going into cities with limited airline service. Its financial model is low debt and high cash, unusual for an airline, although their debt has spiked over the last several years on swapping its fleet to A320s. Additional debt is likely to be raised for its resort expansion described below, too. Allegiant expects its costs to increase slower than revenue increases, allowing for margin expansion—operating leverage. Although, it has a track record of doing this successfully, I’m expecting this to be challenging going forward, but that would be upside if I’m wrong. Fuel and employee pay are its biggest expenses by far. Fuel is hard to control (they manage this through capacity changes), and employee pay is likely to go up as experienced pilot shortages are impacting the industry. Cost controls are a key cultural and business model advantage for Allegiant, but also what they must watch like a hawk to maintain the model successfully.
Allegiant, like all ULCCs, faces complaints about all its additional fees and lack of legroom, but the reality is that most leisure travelers want cheap airfares more than frills (a tendency Ryanair has exploited to the max). Many complain about Allegiant’s lack of amenities, but the numbers show that people keep coming back for the low fares. Put plainly, Allegiant’s consumers care more about transportation from remote destinations to sunny locations.
Airline Competition
Spirit (SAVE) is a high frequency airline with the newest fleet of A320’s out there. Southwest overlaps with 62% with its routes and American: 51%. Spirit focuses on leisure passengers with Fort Lauderdale, the Caribbean and Latin America as big destinations. 25% of its routes are greater than one flight per day, 50-60% are 1 flight per day and less than 15% are less than daily. It flies 1/3 big city, 1/3 leisure and 1/3 international, with expansion plans focused on international through Florida as a connection. This model is closer to Allegiant’s, and certainly has some overlap, but also distinctly different, especially with newer aircraft, higher frequency, and international destinations. As a remote possibility—and this is pure speculation—I could see Spirit buying Allegiant to bolster its service to and through Florida. With matching fleet type (but not age) and a big focus on Florida, acquisition seems more likely to me than Spirit deciding to go head-to-head with a low frequency model into small/mid-sized cities.
Next is Frontier Airlines, which is closest to Allegiant in enplaned passengers, but again quite different otherwise. Like Allegiant, they operate A320s, but they have one of the newest fleets. They operate mostly out of bigger cities: Denver, Atlanta, Chicago, Philadelphia, Las Vegas, Orlando, San Antonio, Raleigh, Cincinnati, Cleveland, Austin. They have around 300 routes to approximately 80 cities, some routes into the small cities Allegiant serves. In some ways you can see overlap: A320s and a few small and mid-sized cities, but in other ways not: new aircraft, mostly major cities, greater frequency. They provide some competition, but it looks like Frontier is pursuing a different strategy, at least for now (it’s owned by a private equity firm that could change the model if they believe they can make more money on it).
Sun Country is only 1/6 the size of Allegiant in terms of passengers, but has hired two ex-Allegiant executives and is trying to rescue a troubled business (Sun Country is also owned by a private equity firm). It operates around 70 routes, operates a fleet of around 30 737s that are new to 18 years old (average age around 14 years). It operates out of Minneapolis and serves around 45 destinations including Dallas, Fort Myers, the west coast, the Caribbean, Latin America. So far, it’s a different model, but that could change if they think they can gain on Allegiant. The key question is what would Allegiant’s response be, and could Sun Country weather that storm? Such a fight would reduce Allegiant’s margins, no doubt, and there would be little gained for either side, so that doesn’t seem like an imminent threat.
A new entrant is, I believe, the biggest competitive threat to Allegiant’s airline business. I think Allegiant operates at very low cost and would defend its small markets vigorously. So a competitor—whether large or small—would have to be well-funded and able to tolerate a lot of pain to win market share, and such a challenger would have to be convinced such an effort would be worthwhile relative to its scale and return expectations. More specifically, I think more than one competitor operating in those small markets would make it unprofitable for everyone, too, which makes such a proposition seem difficult. It’s not impossible, and bears close watching, but doesn’t seem like a looming threat for now.
Allegiant Travel, resort development
So, why on earth would a growing niche airline with good competitive positioning consider getting into resort development? The answer lies in the question: a growing niche airline won’t remain niche forever. Allegiant realizes its growth is limited: if it keeps growing into mid-sized cities, it will eventually grow into its competitors, who will want to compel Allegiant to play their game. Allegiant’s management recognizes this, and I think that’s why they are considering new business avenues and opportunities, which brings us to Sunseeker.
Put bluntly, Allegiant doesn’t want to just keep adding airplanes forever, moving further into competition with bigger rivals. So how best to allocate capital given its model of low cost/low frequency travel for leisure travelers to sunny destinations? The answer: exploit Florida traffic. Almost 50% of Allegiant’s customers already fly to Florida. Those customers spend 5-10% of their vacation budget on airfare, and someone else gets the other 90-95%. Why not try to take a piece of that pie? Allegiant has experienced very strong growth in Florida travel, and visitors make long stays to the state. Air traffic is currently out-pacing hotel growth, too, at least where Allegiant is looking to build a resort. It has great data from its airline business, and believes it can disrupt the travel industry by leveraging its Midwest customers’ desire to visit sunny Florida. The plan is to market to Allegiant’s current and potential customers. Remember, it makes most of its money on ancillary fees, not airfare, per se. Why not expand the ancillary fee that’s more profitable instead of the airfare that’s less so?
The overall approach is to sell direct to Allegiant’s customers, just like the airline. Instead of passing its customers off to other hotels and resorts, market them on Allegiant’s own resort: Sunseeker. Allegiant’s customers skew affluent, and it believes it only needs one out of 30 to one out of 15 of those customers who are flying to Florida, and in particular its Punta Gorda destination, and it can fill the resort. Why Punta Gorda? Not only is it a big Allegiant airport, with 80% of the airport’s traffic due to Allegiant, but there’s little resort/hotel competition in the area. Southwest Florida is underserved. There is less development there, and the inventory is old. On average, the hotels/resorts are 26 years old. Less than 10% were built post 2010. There are only around eight large resorts in the area, with an average age of 37 years. There are also few high end or unique food and beverage options available. Looking at the data, Allegiant thinks it can get 90+% occupancy, because the best product gets the best occupancy rates and that’s what it is planning to build. Its research into Airbnb and others shows this to be the case. It’s targeting a luxury to upper scale market, with $185+ hotel and $360+ condo rates per night.
Allegiant bought 22 acres on the sly (the president, who has hospitality/gaming experience, saw the potential and acted boldly), and are currently developing seven of those acres. It’s cheap waterfront, not beachfront, property. Allegiant has a $420 million budget, $125 million of which will come from the airline business, and expect to build a 500 room hotel as well as condo towers with around 190 suites. They have plans for a marina, restaurants and bars. They’ve even acquired a golf course. The location is just a short drive from the Punta Gorda airport, giving Allegiant steady access to customers (current and potential) flying there. The project is cheap by design (no carpets, easy to clean/maintain, direct marketing, etc.), which is what you’d expect from Allegiant. With its low-cost focus, it expects EBITDA margins of 38-40% (assuming 90+% occupancy). Allegiant is planning meeting spaces, too, to mitigate occupancy and day rate risk, with advanced bookings that will smooth out seasonality. September is a slow month in Florida, and a great time for meeting spaces and rooms to be filled. Too, this dovetails nicely into packaging and convention opportunities. Allegiant also sees management and franchise opportunities. This is a business Allegiant has long been involved with because of their 3rd party selling of hotels to customers. It foresees such a franchise/management business giving a small boost to revenue but a big boost to profits, as other hotel and resort franchisers like Hyatt, Hilton and Marriot can attest to. It will also allow them to play the revenue management game with distribution partners. An airline business is no stranger to the revenue management game. As mentioned above, Allegiant’s president came from the hotel and casino business (spending most of his time operating in Vegas), and he’s brought in seasoned managers to build and operate the resort. It has already hired an operator from MGM’s hotel business, an experienced builder with an excellent record, and a proven restaurant and bar expert—also from Vegas. This doesn’t appear to be a B-team of newbies, but experienced managers who know what they’re doing.
If you’re really interested in understanding Sunseeker, the strategic reasoning behind it, and what the management team at Sunseeker will look like, I recommend listening to Allegiant’s investor day presentation.
Do I think Sunseeker is a slam dunk? Definitely not. I have yet to read about an airline successfully entering the resort business (if anyone has, please let me know!). Just because it hasn’t been done doesn’t mean it can’t be done, but the burden of proof is definitely on Allegiant. The market isn’t just not giving them credit, they are assuming both the airline and resort business will flop judging by its stock price decline. In many ways, I don’t blame them. A greenfield resort like this would be difficult to pull off for anyone, but for an airline to try it seems almost rash. It’s true, Allegiant has the benefit of customers already coming to the market on its planes, and a lot of experience selling 3rd party services like hotels and rental cars and even vacation packages. It also has an extensive database of information about those customers and what they do when they come to Florida generally and Punta Gorda specifically. But, Allegiant must get a sufficient return on investment to justify this strategy change, and that’s a tall order considering the returns on its legacy business. The question for me, as a value investor, isn’t just can the project succeed, but at what price does the business discount too much the threat of Sunseeker? I’ll tackle that after I first review management, next.
Management
The president of Allegiant, John Redmond, is former president and CEO of MGM Grand Resorts, with more than 30 years of experience in the hospitality and leisure travel industry. In between MGM and Allegiant, he was the CEO of Echo Entertainment Group, a casino operator based in Australia. He’d been on the board of directors of Allegiant from 2007-2013 when he resigned to work in Australia, but then rejoined Allegiant’s board in 2014, from where he became president in 2016. Why did Maurice Gallagher bring a hospitality/gaming guy into an airline business? I don’t fully grasp the answer, but it seems that he foresaw more than 2 ½ years ago that growing the airline forevermore wasn’t a lasting strategy. It’s too early to say whether Gallagher and Redmond are geniuses, simply over-confident, or straight-up poor capital allocators. Time will tell.
Allegiant’s board of directors includes four former airline executives. That’s excellent experience for helping run an airline, but it begs the question of who on the board has the expertise to oversee a resort development business. I don’t have an answer, and that’s a concern. I would be much more comfortable with Allegiant as an investment if there were someone on the board pushing back on the resort strategy, someone with hospitality experience and preferably with a significant stake in Allegiant who was more worried about the growth of their investment than ruffling the feathers of executives and other board members. I can dream, can’t I.
Valuation
What about Sunseeker? I tried to model the business as best I could given the information Allegiant provides and some estimates of my own. I gave Sunseeker a 20% chance of weak, 80%, occupancy, which would decrease eps by $0.27 per share. I used a 25% probability of performing below expectations, 85% occupancy, which would reduce eps by $0.08 per share. If Sunseeker achieves low end expectations of 90% occupancy (Allegiant’s year 1 expectation), which I give a 40% chance, then I see $0.13 additional eps. If Sunseeker achieves 92% occupancy (Allegiant’s year 2 expectation), which I gave a 10% probability, then an additional $0.30 in eps would be made. And, if Sunseeker does well, which I gave a 5% chance with 96% occupancy (Allegiant’s year 5 expectation), then an additional $0.55 of eps would hit the bottom line. As you can see by my eps estimate levels, I don’t see Sunseeker moving the meter much. Sunseeker could do much worse or better than I’m modeling, but this framework gives you a flavor for how Sunseeker seems likely to impact Allegiant Travel as a whole. It could contribute 4% to 7% of additional revenue, and subtract 2% to add 4.5% to net income. It would, however, have a bigger impact on EBITDA. Allegiant plans to fund $125 million of the $420 million project, so debt becomes a bigger player—typical in real estate development and operations. Although it would tend to detract from net income with lower margins, it could contribute to EBITDA with higher margins than Allegiant’s airline business.
Risks
Allegiant’s business model is not without risks. First, there are perils to the top-line, which could impact units, pricing and ancillary fees with declines. Competition, especially new entrants, would threaten revenues, as would a recession, depression, or other economic calamity.
Second are risks to costs. Fuel and pay are the biggest threats, there. Fuel prices going up would compel Allegiant to cut capacity, which would result in lower revenues and worse unit economics, I believe. Lower fuel prices, too, could be an issue if it leads to capacity increases for the industry and makes it profitable for competitors to challenge those low frequency routes. Pay seems likely to be an issue going forward with experienced pilot shortages in the works. I think this can already be seen in Allegiant’s costs, and is likely to get worse before it gets better. From there, additional cost risks come from station expenses at those small and mid-sized origins as well as destination cities, higher depreciation and amortization costs from newer and more expensive aircraft, maintenance costs, selling and marketing expenses, and any other cost.
Additional risks include a plane crash, which isn’t hugely likely but not impossible, either (Boeing, Airbus’s competitor, calculated that A320s crash every 7 million flights, airsafe.com says 0.11 fatal crashes million flights). A crash would impose higher costs and lower revenues for some period. Information technology security is always a risk, too, and that risk is growing both in probability and impact on revenue and costs. FAA restrictions both on maintenance and air traffic are another threat. Allegiant tends to issue guidance to Wall Street, which is another short term risk to the stock price, because Wall Street really doesn’t like it when expectations aren’t met, and expectations not being met is as certain to happen in the fullness of time as the sun rising tomorrow morning. Executive departures have been another concern with Allegiant. It seems like many young executives make their name at Allegiant and then move on. After following up on eight departures over the last decade, I didn’t perceive any pattern, but one might assume that Gallagher is too cheap to pay a high price for talent, and so they move on. I can’t blame them, but low costs are the nature of Allegiant’s business, so I would tend to side with Gallagher unless he found someone truly indispensable, in which case I think he’d pay up.
The last big risk I want to address is the Sunseeker resort. This is a major strategy change, and thus a significant risk to the current and future business model. Will they generate the returns they expect? Will competitors drive down room rates and occupancy? Will this distract executives from running the airline? Will airline competitors use the resort distraction as an opportunity to compete on small and mid-sized city routes? Does the board have the chops to oversee a real estate project (not so far…)? I wouldn’t say Sunseeker is Allegiant’s biggest risk, which is clearly fuel and pay costs, but it ranks number three for me and could potentially become number one depending on how events unfold.
Conclusion
Allegiant is a highly efficient airline with a niche business model and very few competitors in its space. Its model isn’t dead, yet, having several more years of growth before running into competitive limits. Allegiant is branching out from being purely a cheap airline operating used aircraft to small and mid-sized cities in a new direction: resort development. There are some intriguing characteristics about this opportunity, including targeted customers already served by Allegiant in a destination with few strong competitors, but there are also big risks in that resort development and airline operations are very different businesses, and Allegiant has no track record as a resort developer. The management team at Allegiant includes a very experienced airline CEO and an experienced hospitality/gaming president. Both have good records of capital allocation and operational execution, so they can’t be written off out of hand. The valuation at Allegiant looks very interesting despite several risks and threats that must be weighed carefully. I think it will be very interesting to see how Allegiant grows and how its resort project comes off. Who knows, it might even make a strong investment.
01-18-2019, 08:46 AM
#3
On Reserve
Joined APC: Nov 2008
Posts: 20
Originally Posted by tyler durden
Interesting read. Source?
This investor(?) brings up valid concerns with a seemingly well-researched perspective, free of the appearance of bias and well balanced (praises G4 leadership, past successes).
This investor(?) brings up valid concerns with a seemingly well-researched perspective, free of the appearance of bias and well balanced (praises G4 leadership, past successes).
The unabridged version can be found here:
https://seekingalpha.com/article/423...changes-course
01-18-2019, 04:58 PM
#5
Gets Weekends Off
Joined APC: Feb 2013
Posts: 218
Very interesting reading indeed.
Especially that part where it says: "...when a business that’s had success in its market niche decides to allocate capital to a totally new strategy, you should run, not walk, for the exit."
Especially that part where it says: "...when a business that’s had success in its market niche decides to allocate capital to a totally new strategy, you should run, not walk, for the exit."
01-18-2019, 06:28 PM
#6
Banned
Joined APC: Apr 2014
Position: Da Bus
Posts: 481
Originally Posted by LoFly
Very interesting reading indeed.
Especially that part where it says: "...when a business that’s had success in its market niche decides to allocate capital to a totally new strategy, you should run, not walk, for the exit."
Especially that part where it says: "...when a business that’s had success in its market niche decides to allocate capital to a totally new strategy, you should run, not walk, for the exit."
01-18-2019, 08:49 PM
#7
Gets Weekends Off
Joined APC: Feb 2013
Posts: 218
Originally Posted by disco inferno
I smell a sale/merger in the not too distant future.
I'm very much not an economist. Actually I've found out I'm a millennial, so I'm genetically dumb and emotional.
But.
The guy clearly states, as many were saying, there isn't much growing left. Yes, the next 2-3 years, maybe 10% or so (if we can find planes. Biiig IF: lots of interest in used buss worldwide)... Bla bla. But that doesn't mean they'll sell it! It can't grow much more, so what. I mean, it's not good for the pilot group but we'll still be printing $$$. Let the $$$ keep coming!
I'm very no expert economist, but I know people like to make more and more money, so they're planning this hotel/resort/condo thing (maybe casino, that would do it), along with go-carts and laser tag, in the hope of making that more and more money since the flying gig is reaching a plateau.
Merger with Spirit? I can't wrap my head around it.
01-19-2019, 07:31 AM
#8
Banned
Joined APC: May 2017
Posts: 733
The only way I see Allegiant Air being sold within the next couple years is if they need to raise cash for the resort. If the funding falls through. Or if construction falters. Or if occupancy isn't what they forecast. Or if investors bail.
Seeking alpha is the APC of investors. Anyone can write anything with little credential or background. But his analysis isn't bad. I think everyone would be surprised to see 90% occupancy first year since there was so little interest the condo scheme already got tanked. 90% would be good for Marriott in a new property. But he brings a great point that overall Sunseeker operational profit/loss will have little impact on the company because the airline is so much larger. It doesn't make sense to spend that much on something that will have little effect in the grand scheme of profitability unless you plan on it becoming your core business. The article hits the nail on the head that anyone who knows anything realizes allegiant has just about tapped out its market. Only so many more crappy midwest towns to fly to where we don't have direct competition. We are going to plateau in a few years. I think MG and co have also realized its better to pick peoples pockets for 3-5 days at a time than 2 hours. Also think about how fast MG dumped West jet after everyone unionized.
i think all signs point to them hanging onto the airline another 3-5 years to generate cash and get the resort network going. If they built 5 or 10 of those things I bet they could do well. Imagine if they bought swampland in the DR or Yucatan and built there. Or PR. There is big potential. Then they will dump the airline to the highest bidder and become a resort company. I'm sure the sale will include a long term deal for cheap seats to their resort cities for vacation packages. So people fly into RSW DAB and PHX to go to Sunseeker instead of PGD SFB and IWA. Big deal.
The boys over on the Spirit page are all talking about merger. I bet Frontier/Sprit now, then pick us up in a few years. That would create a airline almost as big as SWA with Frontiers orders. If this is the case look for stagnation to continue in the airline until we are sold.
Seeking alpha is the APC of investors. Anyone can write anything with little credential or background. But his analysis isn't bad. I think everyone would be surprised to see 90% occupancy first year since there was so little interest the condo scheme already got tanked. 90% would be good for Marriott in a new property. But he brings a great point that overall Sunseeker operational profit/loss will have little impact on the company because the airline is so much larger. It doesn't make sense to spend that much on something that will have little effect in the grand scheme of profitability unless you plan on it becoming your core business. The article hits the nail on the head that anyone who knows anything realizes allegiant has just about tapped out its market. Only so many more crappy midwest towns to fly to where we don't have direct competition. We are going to plateau in a few years. I think MG and co have also realized its better to pick peoples pockets for 3-5 days at a time than 2 hours. Also think about how fast MG dumped West jet after everyone unionized.
i think all signs point to them hanging onto the airline another 3-5 years to generate cash and get the resort network going. If they built 5 or 10 of those things I bet they could do well. Imagine if they bought swampland in the DR or Yucatan and built there. Or PR. There is big potential. Then they will dump the airline to the highest bidder and become a resort company. I'm sure the sale will include a long term deal for cheap seats to their resort cities for vacation packages. So people fly into RSW DAB and PHX to go to Sunseeker instead of PGD SFB and IWA. Big deal.
The boys over on the Spirit page are all talking about merger. I bet Frontier/Sprit now, then pick us up in a few years. That would create a airline almost as big as SWA with Frontiers orders. If this is the case look for stagnation to continue in the airline until we are sold.
01-19-2019, 07:42 AM
#9
Banned
Joined APC: Apr 2014
Position: Da Bus
Posts: 481
The only way we can grow significantly is to go head to head with other ULCC's on bigger market routes. Why lose money doing that when we could be sold or merge and still feed their resorts? I still think Allegiant's days as we exist now are numbered.
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