Should This Airline Launch a Share Buyback?

Should This Airline Launch a Share Buyback?

There's one big problem with share buybacks: When a company has the cash for a buyback, shares are often expensive. And when they're cheap, the company probably needs that cash for other, more important things. But sometimes, a company has plenty of cash (and the earnings to back it up), but remains undervalued. For an example, look no further than US Airways .

Undervalued vs. peers

The company hasn't announced any plans to buy back shares, but it might want to consider doing so. Trading at less than six times earnings, US Airways has a significant P/E discount when compared to Delta Air Lines at 11 times earnings, and United Continental, which actually has negative earnings due to merger related costs.

Unlike so many other companies with a single-digit P/E ratio, US Airways is not in a perpetually declining business. In fact, most analysts expect earnings to remain at least near the $3 per share level for the next few years with some pointing to estimates in the upper $3 range.

We also see a fair amount of cash per share at US Airways: $19, well above the levels at Delta (<$5 per share) just above United Continental Holdings ($17 per share). It also should be noted that United Continental shares trade at about twice the level of US Airways shares. This large amount of cash is a critical factor in launching a share buyback, since having cash on hand does not require the airline to raise money through debt financing to fund its buyback.

Merger ideas

As industry followers are well aware, US Airways and American Airlines' parent company AMR are going to court to fight for their proposed merger. However, when the Department of Justice filed its merger complaint, it drove shares of US Airways far below their previous highs. If US Airways is confident in the merger's successful completion, it should see this as an opportunity to repurchase shares on the cheap.

The terms of the proposed merger would have US Airways shareholders get 28% of the new American Airlines Group, while AMR stakeholders get the remaining 72%. However, earlier discussions of the merger contained the possibility that the deal would be part cash, part stock, with some analysts even raising the possibility of an all-cash deal.

Had the US Airways management favored a deal that was part cash, as opposed to the current all-stock plan, launching a share buyback now would have a similar effect -- reducing the number of outstanding shares by spending some cash.

If the merger is allowed to go forward, AMR shareholders (who are set to receive 3.5% of the new AAG, plus an amount determined by the value of US Airways stock) would also see the benefits. The new AAG would have fewer outstanding shares, and those repurchased shares would have been bought at a time when the airline was undervalued both in comparison to peers, and for the risk that the merger would ultimately be blocked.

There's precedent

Although airlines do not have a history of shareholder-friendliness, some of them are buying back shares today. Alaska Air Group , parent company of Alaska Airlines, is about a quarter of the way through a $250 million stock buyback, planned to finish by the end of 2014. Even legacy carrier Delta Air Lines has announced its own $500 million stock buyback to be run over the next few years.

Both Alaska Air Group and Delta Air Lines are financially stable enough and have sufficient earnings power to pay a dividend in addition to their respective buybacks. I think debt levels at both airlines are under control, and combined with strong earnings, Delta and Alaska Air's buybacks should be beneficial to shareholders. And looking at US Airways' cash position and earnings expectations, the airline appears to fit the requirements for financial stability.

A good value

Compared to most other airlines, US Airways is highly undervalued, but also has the financial power to repurchase shares at these low rates. If the airline were to launch a buyback, I would view it as highly accretive to shareholders. Whether US Airways ever does it still entirely uncertain-especially since the airline is diverting as many resources as possible to completing its merger with AMR. Nonetheless, examining US Airways shares in this light shows that the airline has another major option for building shareholder value, whether or not the merger succeeds.

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Alexander MacLennan owns shares of Air Canada, AMR, Delta Air Lines, and Gol Linhas. He is also long the following options: $22 January 2015 Delta calls, $25 January 2015 Delta calls, $30 January 2015 Delta calls, $17 January 2015 US Airways calls. This article is not an endorsement to buy or sell any security and does not constitute professional investment advice. Always do your own due diligence before buying or selling any security. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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