MIAMI — Alaska Air Group reported a $148 million net profit for the fourth quarter of 2014 on January 22, delivering yet another quarter of record financial performance despite heightened competition. Excluding a $6 million fuel hedging gain and other special items, its net profit for the quarter (Q4) was still a record $125 million dollars.
For calendar 2014, Alaska reported another record net profit of $571 million excluding special items, up 49.1 percent YOY. Including a net $15 million mark to market fuel hedging gain and other special items, net profit for the year was also a record $605 million.
Quietly, as its larger peers underwent more aggressive and widely covered restructuring, Alaska has very quietly turned itself into a high-quality industrial company. Operating margins for 2014 expanded YOY to 17.9 percent on an operating profit of $962 million.
Furthermore, Full year pretax margin came in at 17.2 percent (up 4.8 percentage points), while ROIC for the trailing 12 months totaled 18.6 percent. Admittedly, much of the gains were driven by fuel prices, but even without that headwind, the numerical improvement was substantial YOY.
For the full year, on an adjusted basis, lower fuel prices contributed $49 million, or 8.3 percent to Alaska’s bottom line on a decline in adjusted fuel price per gallon from $3.28 to $3.03. However in Q4, Alaska paid an adjusted fuel price of $2.58 per gallon, suggesting that Alaska has several million dollars worth of YOY expense reduction coming throughout 2014 if current prices persist (the IATA spot fuel price average for North America is $1.58 per gallon).
Alaska Airlines is still very much in a growth phase. Passengers carried rose 6.8 percent YOY, capacity as measured by available seat miles (ASMs) rose 7.1 percent YOY, and Alaska added more than two dozen new routes. In a normal environment, this would be margin dilutive due to its adverse impact on revenues, and you did see some of that with consolidated PRASM declining 2.4 percent YOY in Q4 (which cannot be fully explained by the after-Thanksgiving shift and increasing stage length).
Furthermore, the strength of the local economy on the West Coast and especially in the Pacific Northwest helped buoy demand. But the massive reduction in fuel costs was the primary driver behind the scope of the expansion in Alaska’s margins.
Since Q2 of 2014, I’ve characterized Alaska’s network re-organization as a necessary project in diversifying its revenue base in the face of heavy competition from Delta at its highest margin hub.
My reasoning was that while Alaska’s growth might dilute overall margins to some extent in the short run, the long run benefits of doing so would outweigh the short run travails, especially given the strong macroeconomic conditions in the U.S. But fuel prices will buy Alaska more time. Now, its new routes will have an extra year or so to mature in a low pressure environment, likely resulting in another yearly cycle of record profits.
There were several interesting items that came out of Alaska’s earnings call, and without diving too deeply into the details.
Here are a Few that I Found Notable:
- 2014 Free Cash Flow was $344 million, while operating cash flow was $1 billion.
- On time performance was 86 percent, completion factor as 99.5%, and Alaska recorded a blended satisfaction score of 84 percent, a record.
- Competitive capacity rose 7 percent in Alaska markets, 8 percent in Q4.
- Alaska launched 16 new North American markets in Seattle (up to 79 total versus 26 for Delta). Seattle market share is 55 percent.
- The seat retrofitting program on 737-800s and 737-900s has been completed, generating incremental benefit of $50 million annually.
- Mileage Plan frequent flyer members were up 11.4 percent YOY.
- Q1 2015 capacity growth projected at 11 percent, with 4 percentage points due to aircraft up-gauging. Calendar 2015 capacity growth is expected at 8 percent.
- Paid first class traffic up 7 percentage pints in Q4 on roll out of discounted first class to 50 percent of markets by YE 2014.
- Preferred seating product in Q2 for exit rows and bulkheads expected to add $15 million to the bottom line.
- Revenue is management system being updated in Q1.
- Profit sharing and incentive pay totaled $116 million, $14 million for operational performance rewards.
- A large portion of the Q400 fleet is entering an engine overhaul cycle.
- All 27 737-400s will be replaced by 737-900ERs by the end of 2017.
- Mileage Plan growth has been highest in Salt Lake City and San Diego, new markets with a small base.
- Oil prices have not had a major impact on volatility in State of Alaska demand. Alaska views the key oil towns as Anchorage and Prudhoe Bay on the North Slope, and it views North Slope projects as stable in the long run.
- The 737-900ERs enable reasonably cost-neutral expansion in Hawaii.
- Reduction in oil prices may hurt local consumer demand in Alaska.
- Alaska wants to move up into the S&P 500.
- Alaska’s fuel hedges versus those of Delta are not expected to affect competition in Seattle.
- E175s expected to drive strength on long and thin routes.
- Competitive capacity growth tails off over the course of 2015.
- Business travel represents 30-35 percent of Alaska’s revenue.
- Alaska is planning for the future as if fuel prices will be $2.90 per gallon.
Without diving too deeply into the specifics, the regional growth Alaska is pursuing is very interesting. Unlike the legacy airlines, Alaska is actually growing its regional business (3.6 percent YOY in 2014), and the recent decision to add yet more incremental Q400s and grow the E175 subfleet is interesting.
The Q400s at least make some sense in that even if fuel rises, the fact that they are turboprops means that operating margins won’t suffer to deeply. The E175s on the other hand, while useful in a legacy sized network, might be difficult for Alaska to utilize during cyclical downturns.
Remember, Alaska operated a subfleet of Bombardier CRJ700s on similar routes up until the global financial crisis, before largely abandoning those aircraft in favor of the Q400s. The structural conditions of the airline industry are infinitely better now than in 2009, but even so, this decision may prove unwise in the long run.