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Author: mkha Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 580  
Subject: Re: Fair Price? Date: 2/1/2001 9:52 PM
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I know this is a issue that cannot be easily quantified, but in general, does FRNTs price seem fair right now? They have been up, and up for quite awhile, and though I am confident in future growth, I am a bit concerned about a slight pullback due to people cashing in on a great year. They seem to have a nice upward growth trend (not choppy) but I would like to hear what everyone else thinks.


Marc,

That's a rather unfair question. Really, if anyone here had a crystal ball like that, I think they'd already be filthy rich and not bother hanging around the boards here. Ultimately, no one knows if the market as a whole or any specific stock will go up or down. I really would need a crystal ball to tell you how much Frontier will go up, if it will go up at all. That "if" is very critical. The stock may not go up. This may be the greatest the company will ever become and there's nothing more left to hope for. Next month they could be out of business.

Is that realistic? I don't think so. I think Frontier is a great company. I expect it to go up. I'll even support my argument, but the most important thing I want you (and any other readers) to keep in mind is that I'm human, very fallible, prone to math errors and I'm familiar with the airline industry from the standpoint of flying coach. That gives me no divine knowledge.

With that said, on to the facts.

The guy who impressed me most this past year is Sam Addoms, Frontier's president. That's a very serious statement. It's not Bill Gates, it's not Alan Greenspan, it's not Warren Buffett. It's not even Bush or Gore. Addoms is a spectacular manager. He's had a very successful three decades in management, all backed by a degree in English Lit. Don't laugh. Frontier's performance is a testament to his knowledge and skill.

Take a look at Frontier's latest (September 30, 2000) 10-Q. Almost $119 million in raw cash. And that's a 42% improvement over the 10-K from fiscal year end (March 31, 2000) -- 42% growth in 6 months! What's even more amazing in this day and age of debt in the airline industry, Frontier managed to get here completely debt free. In fact, if they were to close up shop, take care of all their liabilities and return all the toys, that 10-Q leaves them with $120 million free and clear. Given some 18 million shares, that's a cash value of just over $6.50 per share sitting comfortably in the bank account. And there's no reason to think that the size of that account hasn't grown.

That debt free standing and tons of cash can be easily explained in the airline's revenues. $116M in 1997, $147M in 1998, $220M in 1999 and $330M in 2000. That's a growth of over 40% per year! And all while doing battle with United and WestPac. Of course growth is irrelevant if expenditures aren't properly managed. Frontier ran up bills of $130M in 1997, $166M in 1998, $196 in 1999 and $290 in 2000. While revenues were zooming up, costs went up only 30% per year. That's a sign of good management right there. It doesn't get much better than this.

Let me focus on Frontier's current numbers. Current P/E is 14, compared to 22 for UAL, 10 for Continental, 25 for Southwest, 7 for Delta. That's actually very conservative considering TWA, Vanguard and US Air are flying and losing money all at the same time. The P/E is a popular metric that TMF likes to refute, but personally I like to glance this way occasionally to make sure that nothing ridiculous has happened.

TMF indicates that "In a fully and fairly valued situation, a growth stock's price-to-earnings ratio should equal the percentage of the growth rate of its company's earnings per share." Thus let's look at the PEG (even though the Fool reminds us that airlines are cyclical and the PEG isn't a good valuation here). Plugging in all the numbers, we get a PEG of 0.73, which comes splat in the middle of the "fairly valued" range. That, of course, doesn't mean that the stock's about to tank. It simply means that they're fairly priced.

Quick ratio (inventoryless liquidity), current ratio (assets to liabilities) and cash ratio (ability to cover liabilities) are (respectively) 1.53, 1.55 and 1.01. A ratio of 1 or greater is desired for a company to be in good financial shape.

The Foolish Flow Ratio is 0.54, well below the 1.25 desired requirement. Between this number and the look at Frontier's revenues above, it's hard to say they're not handling their cash flows correctly. Adding to this, the Cash King Margin is 18.10%, well beyond the minimum 10% requirement the Fool wishes to see.

Other margins are also very nice. The gross margin is 65.52%. Net margin is 15.02%. These are rule maker territory numbers. Is Frontier a rule maker? No. That's of course not a big surprise since Frontier is very young and with a very small scope. It's a joke to consider this airline a rule maker when their revenues are just 30% of the minimum required to be on the rule maker list. If anything, Frontier is closer to being a rule breaker as it's redefining how an airline should do business and challenging some traditional notions. But I wouldn't call them a rule breaker, either. The industry isn't new or innovative. There's nothing truly inevitable about airlines.

The reason Frontier caught my eye originally is because it matched the F8 criteria and, since then has matched Zeke Ashton's "mini-maker" criteria as well (and rather well). Even today, taking the highest constraints from all these methods leaves Frontier looking very good. Take a look: sustained sales growth of over 25% (41.65% for FRNT), gross margins over 50% (65.52% for FRNT), net margins no less than 10% (15.02% for FRNT), cash to debt ratio of at least 3-to-1 (FRNT has no debt), foolish flow ratio under 1.25 (0.54 in FRNT's case) and a cash king margin of at least 10% (FRNT is at 18.10%). Finally, they recommend that a company be at least 15% owned by insiders to show vested interest. Frontier is 31% owned by its management. Everything is being done just right.

A quick and dirty analyst trick for setting price targets is to use the future earnings estimates (future EPS) and multiply it by the current P/E. The First Call survey sets the year 2001 (March 2002) EPS at 2.86 and with the current P/E of 13.83, the early 2002 price target can be estimated to be around $39.50.

A future EPS of 2.86 means that the stock is currently trading at a 16% discount to next year's P/E.

To be fairly valued, it is assumed that a stock's P/E should match growth and with Frontier's growth estimated at 19% over the next five years, the P/E would theoretically rise to average this number. At an average analyst projected growth of 19% (which is a significant drop from the current 41%), the 2006 EPS would be $5.70. Multiplied by a P/E of 19 places the five year price at $108. If you want a rosier picture, Sam Addoms said he expects growth to be more in the 20%-21% range.

That's what you wanted to see, yes? Well, let me remind you that you're looking into a broken crystal ball. There are a lot of things that impact a company's performance. Frontier got lucky with when it started up. There was a new airport transition and Denver's desire to make it "bigger and better". There was Continental pulling out of Denver. A major economic boom. Combined, all these made for a very favorable incubation environment for Frontier. Of course this was countered by high fees at DIA and Frontier's battle for market share with WestPac and a price war with United. Frontier won because they grew smarter than WestPac and because Denver told United to lay off or face unfair competition charges. The fact that United's pilots and mechanics picked a fight with their employer helped Frontier as well. Disgruntled customers flocked to Frontier and boosted profits into record territory. Does that mean the tough times are behind Frontier? No.

Consider this. An airline's main expense is gas. The price isn't getting cheaper and even though Frontier can hedge this by using the more efficient Airbus fleet, the prices will still be going up in the long run. Talking about the Airbuses, they will need to be financed. I recall reading somewhere that an Airbus A319 runs about $30 million. At 11 of these birds, the $120 million free cash Frontier has on the books becomes a very small number. Add to that Frontier's pilots hinting they want a raise that will put them on par with United and you have turbulence. And that's in good economic times. What if all the doomsayers are right and we're on the verge of a recession? People won't fly as much when they don't have money. Frontier would have to cut prices, take on debt. That would damage the stock price. What if a new airline starts up in Denver or an existing airline decides to add a hub in Denver? That would be a major hit to Frontier's market share. The transportation industry is cyclical with the economy and it's important to keep an eye on the indicators. Economic downturns hit the airlines as hard as they hit the auto industry. Could Frontier survive something like that? With a solid war chest, yes, but will they still have that after the Airbus transition?

At the 2000 shareholder meeting the management spent a lot of time talking about the airline's growth and future plans. I have ten pages of handwritten notes about goals and objectives and strategy. I don't have a business degree, but my analytical mind likes the sound of what the management plans. They're realistic and practical and they already have a good track record in two turf wars with other airlines. At this time I'm not ready to jump ship to look for "the next best thing".

What you're really asking, I think, is if Frontier's stock will see another tripling (or even doubling) in the next year or two. I sure hope so, but to be completely honest, I don't see that happening. Small things grow fast, but at this point in its life, Frontier is a pretty big teenager. Sure it has much growth left in it, but I don't believe that's 300% worth of growth in a single year. I can't and won't tell anyone if they should or shouldn't buy this stock. That's a decision people have to make on their own. Are you comfortable with the risks? With where Frontier is headed? With how they got where they are?

Frontier will release its Q3 earnings on February 7. I urge those interested to take a listen to their conference call, see what the analysts are asking and what the management has to say. Earnings calls are a good indicator for the direction a company is going in. If you have questions about the company, ask. You have investor relations people to provide answers and this forum to discuss those answers with peers.

Finally, my personal disclaimer -- I am not an analyst. Everything I know about investing is book knowledge. I do own Frontier stock. And I fly Frontier whenever I can get away with it.

Max
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