Buckingham Sees 36% Upside in Virgin America

February 7, 2016

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Buckingham Research slashed its price target and fourth-quarter earnings outlook Virgin America Inc (NASDAQ: VA) on the back of its recently released cost per available seat miles (CASM) outlook. However, the brokerage sees 36 percent upside on the stock, driven by the airline’s fundamentals and attractive valuation.

The company's CASM excluding special items, fuel and profit sharing increased about 4.6 percent for the fourth quarter versus the same period last year. CASM is a key metric in airline industry used to measure how much it costs to operate each offered seat mile.

Analyst Daniel McKenzie cut his fourth-quarter profit forecast by $0.20 to $1.10 a share and price target by $11 to $40, which still represents 9.6 times the company's estimated 2016 earnings of $4.16 a share.

The low-cost carrier attributed the nonfuel CASM due to higher-than-expected marketing costs, lumpy maintenance expense that was moved forward from the first quarter 2016 and crew training costs.

"We've set aside mgmt.'s 2016 cost guidance and separately, adopted a more cautious stance on revenue, both largely offset by fuel which softens the EPS impact, hence the nickel trim to our 2016 EPS," McKenzie said in a note. "While competitive capacity remains elevated in 1Q16, industry capacity growth in VA's market nonetheless slows by 200 bps sequentially to roughly +5% in 1H16 (leap-year adjusted). Competitive capacity in its most affected market, Dallas, however slows to +2% (vs +10% in 4Q15)," the analyst added.

However, the airline has room to grow its ancillary revenue. It currently earns $24 per passenger in ancillary revenue versus peers at $32-33 per passenger. Virgin Airline has upgraded its systems and is targeting similar kinds of revenue production.

"We estimate the combined initiatives over time are worth $0.90/share ($10 to the stock)," said McKenzie, who has a Buy rating on Virgin America shares.

The company's shares are down 18 percent this year and trade at about 7x the analyst’s revised estimate, which is attractive valuation for a growth airline.

Virgin Airlines is scheduled to release its fourth-quarter results on February 18. Wall Street expects the company to earn $1.30 a share on revenue of $394.12 million.