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Why Alaska Air Shares Could Soar Another 15% to 20% This Year

NEW YORK (TheStreet) -- Most people think of American Airlines (AAL - Get Report), Delta Air Lines (DAL), and Southwest Airlines (LUV) when discussing U.S. airlines, but the much smaller and thinly traded Alaska Air Group (ALK) is rarely brought up. Despite having gains of 30.33% year to date, Alaska Air is a laggard to its larger competitors, which have positive returns of 69.19%, 34.13%, and 50.72%, respectively.

Delta Air Lines and Southwest Airlines have both been advocates of stock buybacks and dividends recently, but neither has been more shareholder-friendly than Alaska Air. On May 12, Alaska Air's board approved a 25-cent quarterly dividend and a share repurchase program of up to $650 million. This is on top of $42 million left from a $250 million buyback program from September 2012.

Although $650 million doesn't sound large compared to Delta's $2 billion buyback program that will be completed by the end of 2016, Alaska Air has a market cap roughly five times smaller than Delta's ($6.6 billion vs. $32.7 billion). The combined buyback programs of Alaska Air represent a massive 10%-plus of its current market cap. Prior to this announcement, it had repurchased $519 million worth of stock since 2007.

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Dividends are a small part of evaluating whether an airline is an attractive investment because they are few and far between. However, Alaska Air's 1.06% dividend yield is marginally higher than Delta's 0.62% and Southwest's 0.87%. None of the other major U.S. airline companies pay dividends or have buyback programs.

On April 9, Alaska Air reported first-quarter EPS of $1.28, topping the average analyst estimate of $1.02 (an increase of 106% from the first-quarter of 2013). Revenue rose 8% to $1.22 billion. Total first-quarter traffic, a combination of Alaska Airlines, Horizon Air, SkyWest, and Penair, jumped 4.5%. Momentum has carried over into the second quarter with June traffic rising 5.3% year over year with capacity expanding 5.5%. Second-quarter earnings are set to be released July 24.

Alaska Air trades at a price-to-earnings ratio of 11.9 (based on 2015 earnings estimates), which is very cheap on a valuation basis when factoring in the expected 12.5% EPS growth (price-to-earnings-to-growth ratio of 0.95). Revenue will grow 5.9% next year, according to Wall Street estimates. (The stock trades at a price-to-sales ratio of 1.3). The average analyst price target of $108 is more than 11% greater than the current share price. On May 27, J.P. Morgan maintained its overweight rating on the stock but raised the price target from May 1 to $113.50 from $111. However, on May 30, Stifel Nicolaus downgraded the stock to hold from buy after it hit the firm's $100 price target from Feb. 25.

Large Call-Spread Buyer Looks for Double-Digit Gains by October

The Oct $100/$115 call spread was put on 10,000 times for a $3.80-$4.00 debit on May 7-May 8. This trade was part of a rollout from 5,000 July $80 calls. To put the Oct $100/$115 call-spread buyer into perspective, of the 32,829 call open interest, this trade represents 62% of the existing open call positions. The trader has a breakeven point of $103.80-$104.00 by October options expiration with upside potential to $115 (max gain is roughly 285% on a close at or above $115 on expiration).

Low-Risk Entry Point on The Weekly Chart

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