Like many winter-weary travelers, Alaska Air Group, Inc. (NYSE:ALK) is getting into a tropical mood this time of year.
This month, the Seattle-based airliner announced a plan to acquire depressed peer Hawaiian Holdings for approximately $1.9 billion inclusive of debt. Regulatory and shareholder approval hurdles remain but the transaction would create a strong passenger air travel company focused on popular West Coast and Hawaiian destinations.
The news comes just a few months after wildfires in Maui devastated the island and tourism in America’s 50th state. Hawaiian Holdings’ subsidiary Hawaiian Airlines has been hurt by the event, as have its shareholders.
For most of October and November, Hawaiian’s stock price languished in penny stock territory below $5.00 — after climbing above $30 on economic reopening optimism. HA shares have nearly tripled on the buyout news.
For Alaska Air shareholders, however, the market’s reaction wasn’t so good. ALK descended 14% on the day of the announcement on concerns around merger execution in an uncertain macro environment and other deal-related risks. Last week, both Deutsche Bank and Raymond James downgraded ALK from buy to hold.
In recent days, ALK has started to recover from its $32.00 low. An upward-trending market gets some of the credit — but investor sentiment around the deal may also be changing.
Is Hawaiian Airlines a good fit for Alaska Air?
Hawaiian is a natural fit for Alaska Air for several reasons. For starters, the company already operates in Hawaii. It offers long-haul east/west flights to and from the islands in addition to service to over 100 cities across the U.S., Canada, and Mexico. By combining with Hawaiian Air, Honolulu will go from an auxiliary hub to a key hub, making Alaska Air an authority in the Hawaiian air travel space.
The company will still face heavy competition from Southwest Airlines and others but will be better equipped to fend off challengers. The acquisition will expand the fleet of the nation’s fifth-largest airline to 365 planes, giving it greater influence over the market supply, demand and pricing.
It will also give Alaska Air a commanding presence in a Hawaii tourism industry that is bound to recover over time. This week, Hawaii News Now reported that travelers will largely avoid the islands during the holidays because of media-led confusion around rebuilding progress and an inclination to give locals space to heal. But with the governor officially welcoming visitors to return, 2024 could usher in a strong rebound in pent-up leisure travel demand.
From a financial perspective, Alaska Air expects the deal to create value soon after takeoff. Management forecasts that Hawaiian will be accretive to earnings within two years of the close and create at least $235 million of run-rate synergies.
Regardless of the near-term impact on profits, Alaska Air got a great deal. It paid just 0.7x revenue to purchase an airline with exposure to one of the world's most sought-after travel destinations. Given the wildfires and costs tied to reconstruction at Honolulu airport, this turnaround story will take time to boost Alaska’s financial performance materially. But unlike a lengthy flight delay, this will be well worth the wait.
Is Alaska Air stock undervalued?
Wall Street estimates for Alaska Air are likely to change in the months ahead as we learn more about the regulatory and shareholder approval process. As we witnessed with the JetBlue and Spirit Airlines merger, airline industry M&A can take a lot of time to play out — especially if other bidders get involved.
For now, though, analysts are predicting that Alaska Air’s earnings per share (EPS) will grow 13% to $5.05 in 2024. This gives the stock a forward price-to-earnings (P/E) ratio of around 7x. It is a valuation that is in the bottom third of the passenger airline group. United Airlines is cheaper at 4x 2024 earnings. Southwest Airlines is significantly more expensive at 19x next year’s earnings.
Plenty of uncertainty remains around acquisition closure and integration. But assuming the deal goes through, Alaska Air looks well undervalued here. With newfound exposure to a Hawaiian tourism industry that has likely already bottomed, a case for a premium valuation can be made.
Alaska Air doesn’t pay a dividend but did resume share buybacks this year. The company repurchased $70 million of its own stock through the first nine months of 2023, a practice that will probably accelerate given the post-acquisition price decline.
Expect buybacks and improving sentiment around snagging a crown jewel asset at a bargain price to provide support for ALK. The stock will likely be choppy, but smoother air is ahead.
