As I’m writing this I am currently waiting on for a Southwest flight from Nashville to Philadelphia. To keep with the theme, today I will be reviewing an airline stock. The company does not actually make my ugly ducklings list as the price to net tangible assets is currently a little high at 1.1, but it meets my other criteria with flying colors (enterprise value to revenue at 0.10, price to earnings at 3.8, growth at 5.1%).

For the past 20 years, the airline industry has been a pretty lousy place to be invested. Financial pain in the industry has been very real with many companies declaring bankruptcy including Northwest, United, Delta, US Air, Mesaba, and Independence Air. The pain inflicted by 9/11 and high oil prices has led to significant underinvestment in the industry over the past 5 years. Additionally, investor mentality has set in that airlines are a mostly unprofitable place to invest and it is cyclical. Because of this, some bargains are beginning to appear in the industry. One such bargain is Express Jet (XJT). Based on the financials ratios, the stock is a good value:

Stock Price: $5.89

Market Cap: $318 million

Revenue: $1.68 billion (ttm)

Net tangible assets: $288 million

Net cash: $150 million

Enterprise value to revenue: 0.10

Price/earnings: 3.8

Price/net tangible assets: 1.10

Revenue Growth 5.1%

The enterprise value to revenue ratio of the company is significantly lower than the competition. Most airlines trade between 0.5 and 2.0. The P/E is also incredibly low at 4. The mentality has set in that the current profitability in the airline industry will soon return to “normal.” The round trip flight I am waiting on is up about 10% from last month costing $250. I remember when American Airlines made this same flight in 1990, it routinely cost $742. While 10% more feels big, there is plenty more room for higher prices. For Express Jet to sport a P/E of 3.8, people obviously view the current earnings as unsustainable. I’m of the opinion that not only are they sustainable, but airlines will become more profitable as they will be somewhat supply constrained.

With the significant underinvestment over the past few years, the companies holding airplanes and gates will find their assets worth more that they are currently listed on the books. It would be possible for companies to buy more jets, but Boeing is already backlogged and why would an airline want to go buy a fleet of new jets when they can buy a competitive airline cheaper. This is exactly the same condition the oil industry experienced in 1999-2000 (cheaper to buy than drill) and the steel industry experienced in 2003-2004 (cheaper to buy than build). Depreciated assets on the book were worth more to the buyers than building new ones. This is especially true for airplanes as the construction costs are up as aluminum and titanium prices have risen sharply over the past few years.

Another airline in a similar position to Express Jet is Mesa Airline (MESA).

Sell Targets

Based on the financial ratios for other airlines and stocks in general, Express Jet has the potential to increase significantly in value. I do not set price targets for selling, but rather financial ratios at which I sell. As a company performs well or poorly over time, these price targets change. Once I accumulate my shares, I will sell the stock in five equal fractions. Here are my five sell targets for Express Jet (XJT):

Sell 1: 0.5X net tangible assets (currently $18.37)

Sell 2: 0.75X Enterprise value/revenue (currently $26.16)

Sell 3: 1X EV/Rev (currently $33.95)

Sell 4: 1.5X EV/Rev (currently $49.54)

Sell 5: 2X EV/Rev (currently $65.12)