Enterprise value plus operating leases to earnings before interest, tax, depreciation, amortization, and rent
For a capital-intensive industry like airlines, we use the EV/EBITDA (or enterprise value divided by earnings before interest, tax, depreciation, and amortization). This is because in a capital intensive business company’s often end up taking varying levels of debt. EV/EBITDA is a capital-structure-neutral ratio (it takes both equity and debt capital into account), so it allows us to compare companies with different debt levels.
We, however, go a step further for airlines. Airlines often use operating leases to buy aircrafts, resulting in huge rents paid. To neutralize this, we use the EV+ operating leases/EBITDAR multiple (or enterprise value plus operating leases to earnings before interest, tax, depreciation, amortization, and rent) to value airline companies. A forward multiple uses a next 12-month estimate.
As can be seen from the above chart, all three stocks seem to be valued at par. The forward EV+ Op. leases /EBITDAR multiple for LUV stands at 5.42, for SAVE at 5.41, and JBLU at 5.35. JBLU, however, was undervalued as compared to both its peers in the past. A higher leverage ratio than both LUV and SAVE as seen in our previous article may be one of the reasons. On the other hand, SAVE’s valuation has been declining for the past few months. One of the reasons for this may be SAVE’s heavily declining unit revenues (or PRASM).
Which stock is better?
Spirit Airlines has outdone peers JBLU and LUV on most parameters: demand and capacity growth, revenue growth, margins, lower leverage, and return on invested capital. Declining passenger yields and load factor have been a concern lately, indicating that all its growth is coming at a cost. It’s no wonder its valuation multiple has declined.
JetBlue, on the other hand, has not done badly. Increasing unit revenues and passenger yield indicate that all its investments are finally paying off and can lead to higher revenue in the future. JBLU’s declining leverage has certainly helped. In fact, for 2Q15, JBLU’s leverage stands at par with that of SAVE. JetBlue’s success will prove that there can be a third possibility for airlines between full legacy and no-frills carriers.
Both these stocks are definitely worth watching out for. To avoid the risk of investing in a single stock, investors can get exposure to airlines by investing in the iShares Transportation Average ETF (IYT), which invests ~2.5% of its holdings in LUV and 1.6% in JBLU.