MIAMI — Ultra low-cost carriers Spirit Airlines and Allegiant Air, and hybrid carrier Alaska Airlines all reported their earnings for the second quarter (Q2) of 2017 earlier this week, with each carrier reporting a net profit for the period. Allegiant reported a $48.5 million net profit for the period, down 20.3% year-over-year (YOY), while Spirit saw its profits rise slightly to $78.4 million (up 6.9% YOY). Alaska reported a net profit of $296 million for the period, up 13.8% YOY over Alaska-only figures in Q2 2016 and up ~1% over combined consolidated earnings for Alaska and Virgin America together. Here were our major takeaways from the carriers’ quarterly earnings calls:
Alaska’s PSS Integration Is Moving Up
Alaska had initially planned to transition to a single passenger service system (PSS) for things like reservations, flight operations, and check-in by the fourth quarter of 2018, but according to Alaska CEO Brad Tilden, that timeline has been moved up to early in the second quarter of 2018 (less than 10 months away):
“As you know, what is probably the most significant gating item is the migration to a single passenger service system or PSS. Without a single PSS, we can’t have a single airline code, a single set of flight numbers or a single system for sales, distribution, and check-in. Having a single PSS system will effectively mean that we can operate our fleet as one fleet so we’ll have much greater flexibility to assign the right airplane to the right market.
And finally, a single PSS kicks off, a deliberate progression toward a single customer experience encompassing fees, service, common cabin layouts, et cetera. We originally expected to transition to a single PSS in the fourth quarter of 2018, but thanks to some fantastic work by our folks led by Shane Tackett and Sandy Stelling, we now expect to move up PSS integrations to early in the second quarter. This effectively allows us to run Virgin America and Alaska as one airline, and they will provide a whole host of operational, customer and financial benefits. Andrew will talk more about some of these in a moment.”
This means that the timeline for Alaska to realize the synergies from its merger with Virgin America is accelerated. The Los Angeles and San Francisco markets have been subject to a lot of competitive capacity increases over the last 15-20 months, and as a result, the PSS cutover takes on new meaning. Alaska needs every weapon in its arsenal to compete in those markets, and it must be completely merged with Virgin America to maximize the opportunity. Alaska believes that the earlier PSS combination will improve 2018 earnings by an incremental $20 million.
The Facilities Situation In Los Angeles And San Francisco For Alaska Is Stabilizing.
The ostensible rationale for the Virgin America merger was to give Alaska hubs in San Francisco and LA, the two most important west coast hubs in the United States. Route growth in San Francisco has kicked off in earnest, with Alaska adding tons of more point to point nonstop routes, while at LAX the approach has been more tentative. But one big area where progress has been made is in the facilities at LAX, where the two carriers are co-locating at Terminal 6, and San Francisco, where the two carriers will hopefully consolidate at Terminal 2 (the nicest facility at the airport. Terminal co-location matters slightly less for Alaska given that their focus at these airports will be more on origin and destination (O&D) traffic than Virgin America’s was but even so, co-location simplifies operations, reduces costs, and offers a unified customer experience. Alaska’s Benito Minicucci shares:
“Mike, it’s Ben. No. Just so what happened in LAX, Virgin America moved from Terminal 3 to Terminal 6 where Alaska is. And I’d say overall the move went well. We did have some growing pains in the first few months. We are tight on gates at LAX. When things get on schedule, we’ve got airplanes waiting for gates. We have some problematic gates on how to push airplanes out. So, we’ve got work to do with LAWA and we’re working with them hopefully to smooth things out and make things better in LAX, but things are stabilizing well, I’ll say there.
San Francisco, still a lot of work. As you know, we were on the international side. Virgin has just a gorgeous terminal in Terminal 2. We’re going to move a lot more of our flights to Terminal 2 and we’re still operating in international. They are in like a lot of airports. They’re in big construction in San Francisco. So, before we get all in one terminal in Terminal 2, it’s going to be a couple years before that happens. So, it’s still going to be some parts of that operation operating on international and T2. So it won’t be smooth out of San Francisco for another couple of years.”
Allegiant’s Operations Are Still A Work In Progress, But It Should Hire An External COO
“When you look at our operations in the quarter, in Q2, we did not meet our expectations at all and surely not those of our customers. So Scott and others have taken this opportunity to take a real deep dive and examine our policies, procedures, various processes we use, as well as our personnel in or the early part of June. And as a result, we’ve instituted a number of changes around areas like personnel, parts and tooling, better support of our bases, a dedicated effort around AOG, and a much faster recovery with AOS aircraft.
I’ve made the comment in the past, we have great depth and talent in the organization. We just need to direct and did direct more efforts to better managing this talent and to holding people accountable and instilling a higher degree of sense of urgency, if you will.
So when you look at the month of July, realizing that the reaction time has been relatively short and quick, the performance does reflect this focus and the various changes that we have made, which is resulting in a dramatically better measurements against any and all metrics you want to look at, including completion factor, A14, term performance, et cetera. So these significant changes during the busiest time of the year are not a desirable time, but they do recognize the sense of urgency we have around here and this performance is the level that we expect now and what our customer, of course, expect, so very happy with these changes. They represent dramatic improvements over the month of June as well as of course the prior year July.”
Allegiant is also looking for a new COO and in our view, that is a critical hire to help stabilize the organization. But at the same time, Allegiant seems to believe that an internal hire makes more sense. Redmond explains:
“Keeping in mind that if we brought someone in from the street, one, it would take a lot of time, and we didn’t want to sit there waiting for a new person to come in and make changes. When that person got here, just trying to understand the culture, figure out where the bathroom is type of thing, that takes time. And so we knew we didn’t have time to spare or waste, we have a sense of urgency around here and we have a high expectation out of all of us. And we didn’t want to wait. So in taking that deep dive, we have found a lot and we understand a lot more about what we were doing and what could be done better.
So, the things that have long lead times, we have instituted that already, and we’ll continue to institute the changes that we think need to get made. And we will see significant benefits going forward as I said we saw in July already. August and September of course, the middle of August we start to wind down from a very busy summer. And then we will put a lot more effort and energy after that into making our operations that much better.
So while we always look for the opportunity to add more depth to our management bench, if you will, we are busy fixing what we think needs to get fixed quickly. So that effort will direct to looking for at a depth in that role, not for at least six months, and then we’ll see what happens. But that’s why, we just don’t feel when to bring someone on because that person is not going to have the opportunity to make change in a very quick manner, and we wanted to make change in a very quick manner.”
We are not sure we agree. While Redmond’s rationale when it comes to avoiding disruption and a learning curve is reasonable, it is offset by the fact that Allegiant for a long time has had a culture of tolerating operational irregularity and a certain level of operational quality, Cultures don’t change overnight, but even with the right internal hire, it is hard to shit the culture. And Allegiant undoubtedly needs a changed culture.
Allegiant Is An A320 Airline Now
For a very long time, the defining trait and image of Allegiant was that of the McDonnell Douglas MD-80, the aging narrow body jet that Allegiant is more or less the last major operator of in the world along with Delta. But as Allegiant’s Scott Sheldon lays out, Allegiant is increasingly an Airbus airline:
Yeah. I’ll take that really quickly. I’ll get it off hand. But for the second quarter, 55% will be Airbus or was Airbus that accelerates to 63% in the third quarter. So really, the last couple quarters, we haven’t grown Airbus percentage of flying as quickly and the third quarter will be 63%, the fourth quarter will be 70%. So you can see we’ve taken a pretty high gear in terms this Airbus transition after we get through this summer.
The A320 has a modest benefit for Allegiant’s operating economics, but in the short run, it actually does hit company cash flow since the MD-80s were paid for several times over. Now that the 737 MAX and A320neo are in service, it’s time for Allegiant to become an all-Airbus operator.
Spirit’s Battle With Its Pilots Has Been Expensive
For a ULCC, keeping operational costs low is absolutely critical, so it’s no shock that Spirit didn’t react well when its pilots asked for major pay increases. And it is certainly possible that the new government mediation board will side more with management in the kind of pay increases that the pilots can expect. But for Spirit’s management, it may have won a pyrrhic victory, as the costs of the battle were immense. According to Spirit’s Edward Christie, the pilot war caused Spirit’s CASM to rise 10% YOY instead of the planned 2-3%. It would have been 2% without the pilot related expense and cancellation. In all 850 flights were canceled and $25 million in revenue was lost. Christie elaborates
“Had we not incurred the expenses and lost the ASMs associated with the pilot-related cancellations, we estimate adjusted CASM ex-fuel would have been up approximately 2% year-over-year, which would have been far better than our initial guidance for the quarter.
I know everyone is curious about when we will reach a new contract with our pilots. Reaching an agreement on a competitive economic package that allows us to improve our operational reliability is our priority. We are diligently working with our pilots and the National Mediation Board towards that goal. And we will have no further comments as the pace or status of those negotiations.
We continue to move forward with initiatives to improve our operational performance. Matt mentioned our focus to leverage technology to make it easier for customers to do business with us. We are also focused on improving our service levels when things don’t go as planned.
In the past, when trips were disrupted, the customer might miss their next best Spirit flight option because they are waiting in line to see an agent to get rebooked. During the second quarter, we implemented a system that notifies customers when their trip is canceled and automatically suggests the next best Spirit flight option, thus minimizing the inconvenience of getting rebooked. Our goal, of course, is to minimize operational disruptions. When that doesn’t happen, this program is very beneficial in helping us quickly and efficiently find another solution for our customers.”
United’s Hubs Are Now The Eye Of The Hurricane
On earlier calls, Spirit’s CEO (first Ben Baldanza, now Robert Fornaro) has often spoken candidly about the markets that are seeing the most pricing pressure. Historically, those markets were usually hubs for American Airlines, but now according to Fornaro, the most affected markets are United hubs.
“I think it’s mostly the primary markets, at least that involves us are Chicago, and then to a lesser degree Houston and Newark. Certainly, there’s tremendous discounting going on in Denver as well, but we’re not a major participant there. And I’d say very little of the – I’d say increased competition has anything to do with basic economy. In fact, I think I’d say it’s actually rare, in many cases, we’re seeing carriers with a higher cost than us actually charging prices below us.”