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After Virgin-Alaska Deal, Which Airline Stocks are Buys?

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Investor speculation was on a high in the airline space over the past few days, with respect to the sale of California-based Virgin America . Reports had indicated that Seattle, WA-based Alaska Air Group (ALK - Free Report) and Long Island City, NY-based JetBlue Airways Corporation (JBLU - Free Report) were the suitors vying for the carrier, which is partly owned by British billionaire investor Richard Branson. All speculations were finally put to rest yesterday when Alaska Air Group clinched the deal, outbidding JetBlue.

Terms of the Deal

Alaska Air Group inked the deal to buy Virgin America at a value of $57 a share. The offer price represents a premium of over 46% to Virgin America’s closing price on Apr 1. The total deal value is approximately $4 billion, inclusive of debt and capitalized aircraft operating leases. The deal, cleared by the boards of both the companies, is expected to be completed by Jan 1, 2017.

In the event of the merger materializing, Alaska Air Group will expand significantly, particularly in the West Coast, and gain greater access to key cities across the U.S. The transaction is expected to boost the carrier’s revenues by 27% to over $7 billion on an annual basis apart from generating annual net savings worth $225 million, following complete integration. The deal will add more choices for customers with 1,200 departure options per day. The combined entity will boast a fleet size of approximately 280 aircraft. The expansion of Alaska Air Group following the merger will make it the fifth-largest among U.S. carriers in terms of traffic, displacing JetBlue Airways from the position.

Return of Consolidation?

Stocks in the airline space had been in a bad shape financially until a few years ago, leading to companies like Delta Air Lines (DAL - Free Report) plunging into bankruptcy in 2005. However, a spate of mergers led to a rebound in the space. For example, Delta’s tie-up with Northwest Airlines a few years later helped the Atlanta, GA-based carrier climb out of the mess.

Merger-driven consolidation has played an important role in the airline industry, limiting competition. Moreover, operating efficiencies have also largely improved following such mergers. The Alaska Air Group-Virgin America merger, if it goes through, would be the first significant merger in the airline space since late 2013 when AMR (American Airlines' parent group) and US Airways had combined to create American Airlines Group (AAL - Free Report) .

Low Oil Prices Add to Merger Benefits

As stated above, the series of mergers in the airline industry have played a big role in turning around its fortunes. The benefits of mergers have multiplied as oil prices have plunged simultaneously resulting in huge savings for carriers. The extent of the benefit can be gauged from the fact that oil prices are currently hovering around the $35 a barrel mark as against the over $100 level touched by the commodity in mid-2014.

Cheap oil has helped carriers deliver impressive bottom-line performances in the past several quarters, apart from prompting a surge in investor-friendly (dividends and buybacks) and employee-friendly (profit-sharing) activities.

With oil prices unlikely to touch the highs seen in mid-2014 any time soon, the Alaska-Virgin merger (if it happens) should flourish in the favorable backdrop.

Investing in Airlines: A Winning Strategy

With the airline industry in focus at the moment – thanks to the Alaska-Virgin deal – investors would do well to enter this highly talked-about space. The Zacks Industry Rank #53 for the “Trans-Airline” segment places it at the top 1/3rd of the 260+ member industry group and indicates the group’s near-term Positive outlook.  The bullish industry rank coupled with the favorable backdrop, as highlighted above, is likely to make returns in this sector attractive.

To help investors identify which airline companies are worth adding to their portfolios now, we have pinpointed stocks with healthy Zacks Rank and VGM score. Here, V stands for Value, G for Growth and M for Momentum and the score is a weighted combination of these three scores. Such a score allows one to eliminate the negative aspects of stocks and select sure-shot winners. However, it is important to keep in mind that each Style score will carry different weights while arriving at a VGM score.

Our Picks

Air France-KLM SA (AFLYY - Free Report) ), based in Paris, is a provider of passenger transportation services on scheduled flights. Air France sports a Zacks Rank #1 (Strong Buy) and a VGM Score of ‘A’. The company has an expected earnings growth rate in excess of 100% for the current year. The forward price-to-earnings (P/E) ratio for the current financial year (F1) is 4.38, lower than the industry average of 11.

Deutsche Lufthansa Aktiengesellschaft , based in Cologne, Germany, is one of the leading carriers in Europe.  It sports a Zacks Rank #1 and a VGM Score of ‘A.’ The forward P/E ratio for the current financial year is 4.86, much lower than the industry average. The carrier has seen its earnings per share estimate for 2016 go up 6.93% over the last 30 days.

SkyWest (SKYW - Free Report) , a leading regional carrier in the US, was founded in 1972. It is headquartered at St. George, UT. SkyWest carries a Zacks Rank #2 (Buy) and a VGM Score of ‘A.’

The company has an expected earnings growth rate of 8.6% for the current year, well above the industry average of 1.3%. The forward P/E (F1) ratio is 9.23, lower than the industry average.

ANA Holdings , based in Tokyo, primarily offers air passenger and air courier services. The company carries a Zacks Rank #2 and a VGM Score of ‘A’. The carrier has seen its earnings per share estimate for the current year go up over 6% over the last 30 days. The company has an expected earnings growth rate well above the industry average for the current year.

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