Virgin America Likes Tough Markets but Investors Aren't So Sure

NEW YORK ( TheStreet) -- Virgin America ( VA) likes to do things the hard way, a strategy that so far isn't winning friends on Wall Street.

The carrier, which reported first-quarter earnings on Thursday, has about 50% of its capacity in two of the airline industry's toughest markets. In trans-Continental markets between California and New York, a half dozen airlines offer about 75 daily flights each way, including nine on Virgin America.

In Dallas, Southwest (LUV) , Spirit (SAVE) and Virgin America have been rapidly adding capacity since the Wright Amendment, a law that governed traffic at Love Field in Dallas, expired in October.

Virgin America earned 24 cents a share, easily beating the 14 cents Thomson Reuters consensus estimate. Nevertheless, shares fell $1.71, or nearly 6%, to close at $28.71.

The carrier went public in November at $23 -- shares closed at $30 on the first day of trading and reached $43.25 by the end of the year. Shares are down 34% so far this year.

Asked his response to Wall Street's evaluation in an interview on Thursday, CEO David Cush responded: "We take a little bit of a longer term perspective. Our job is to run the company, to make it better, and to tell our story. It is their job to decide what our stock should be priced at."

Cush said the intense competition doesn't trouble him. The trans-con markets are the airline's most profitable, he said. Additionally, he noted, "We started out in the toughest markets -- JFK-LAX, JFK-San Francisco and LAX-San Francisco were our first three routes. We've been in this since day one, so we're used to it."

In the first quarter, passenger revenue per available seat mile (PRASM) grew 2.6% to 10.27 cents, while cost per available seat mile excluding fuel rose 3%. "We still believe this makes us one of the low cost providers in the industry, (yet) we maintain a high quality product," Cush said, on the earnings call. Excluding New York and Dallas, unit revenue rose 7%, Chief Financial Officer Peter Hunt said.

In Dallas, Virgin PRASM fell by 19% in the first quarter. "It was a little bit like the Oklahoma land grab when the Wright Amendment expired," Cush said. "But people are adjusting their capacity now. Our expectation is that we will see significant improvement in ticket values."

Like Southwest, Virgin serves Dallas from Love Field. Through January, Cush said "we are running on par with Southwest in terms of load factor. We think that's a pretty good result." In the fourth quarter, Virgin unit revenue was "higher than Southwest on head-to-head routes," he noted.

A positive sign for Virgin, however, is that the first quarter is a relatively weak seasonal travel period for Dallas and trans-continental markets, a period when Dallas is at 88% of steady-state demand while trans-con is at 82%.

As a result, in the first quarter, "other airlines shift capacity to Florida and the Caribbean," where Virgin America has little presence, Cush said. But this winter, Virgin will begin flying from San Francisco to Honolulu and Maui. "Hawaii generates 110% of steady state revenue in the first quarter, contrary to the rest of our network," Cush said.

Through it all, San Francisco remains a bulwark. "The corporate traffic out of San Francisco is quite extraordinary right now," Cush said on the earnings call. "It's filling up our planes."

Wolfe Research analyst Hunter Keay concluded that "headwinds are real but Virgin American (is) weathering the storm.

Virgin "faces near-term competitive headwinds on the transcon and Dallas, likely mid-term competitive headwinds in Hawaii, and likely longer-term competitive headwinds as {it} grows into other carriers' markets, which we expect to be met with defensive price matching," Keay wrote.

"Thus far, however, VA's PRASM has been better than we thought it would be and VA said they expect 2016 RASM to improve despite likely 14% capacity growth," he said. "That will be challenging." He has a market overweight rating.

Stifel analyst Joseph DiNardi said the 2.6% PRASM increase "was better than expected," but he maintained a hold rating, saying "we remain somewhat cautious regarding unit revenue trends through this year and into next year as (capacity) growth begins to accelerate."

Cowen & Co. analyst Helane Becker is a strong backer -- she has an outperform rating and a $38 price target. "The outlook continues to remain bright as PRASM trends will likely outperform the industry given their focus in San Francisco as well as increased demand in weaker regions," she wrote. "The bears will likely focus on the cost outlook and ignore the underlying fundamental improvement the company has seen."

This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.

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