EV + operating leases/EBITDAR
For the capital-intensive airline industry, we use the EV/EBITDA (or enterprise value divided by earnings before interest, tax, depreciation, and amortization). In a capital-intensive business, companies often end up taking on varying levels of debt. Because EV/EBITDA is a capital structure–neutral ratio (it takes both equity and debt capital into account), it allows us to compare companies with different debt levels.
Because EV/EBITDA is a capital structure–neutral ratio (it takes both equity and debt capital into account), 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 aircraft, resulting in substantial rents paid. To neutralize this, we use the EV+ operating leases/EBITDAR ratio or (enterprise value plus operating leases to earnings before interest, tax, depreciation, amortization, and rent) to value airline companies.
We will be using the forward EV+ operating leases/EBITDAR multiple. A forward multiple uses the next 12-month estimate.
As we can see from the above chart, Allegiant Travel (ALGT) has enjoyed a higher valuation than the rest of its peers throughout 2015. The forward EV operating leases/EBITDAR multiple for ALGT stands at 6.7x. This is followed by Southwest Airlines (LUV) at 6x. JetBlue (JBLU) is valued at a multiple of 5.6x, and Spirit Airlines (SAVE) currently has the lowest multiple of 5x.
Historically, JBLU has been undervalued as compared to its peers. A higher leverage ratio than both LUV and SAVE, as seen in our previous article, may be one of the reasons. JBLU’s declining leverage has certainly helped. For 3Q15, JBLU’s leverage stands slightly below that of SAVE. JBLU forms ~1% of the iShares S&P Mid-Cap 400 Growth ETF (IJK).
On the other hand, Spirit Airlines’ (SAVE) valuation has been declining for the past few months. This is despite Spirit Airlines outperforming its peers JBLU and LUV on most parameters: demand and capacity growth, revenue growth, margins, lower leverage, and return on invested capital. One of the reasons for this may be SAVE’s heavily declining unit revenues (or PRASM).
Declining passenger yields and load factors have been a concern lately, indicating that all its growth is coming at a cost. No wonder its valuation multiple has declined. Allegiant is also beset with similar problems, and investors should keep an eye on both stocks.