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Alaska Airlines Follows Suit with Peers, Announces 2013 Net Profit; Analysis

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Alaska Airlines Follows Suit with Peers, Announces 2013 Net Profit; Analysis

Alaska Airlines Follows Suit with Peers, Announces 2013 Net Profit; Analysis
January 24
06:00 2014

MIAMI — Seattle-based Alaska Air Group reported a net profit of $77 million, or $1.10 per diluted share, for the fourth quarter of 2013 Thursday. The profits were up 77.2% year-over-year (YOY). For calendar year 2013, Alaska’s net profit jumped 12.3% YOY to $383 million, or ($5.40 per share).

Total operating revenues increased an impressive 10.7% YOY to $5.15 billion as the carrier continued to pursue aggressive expansion. Mainline passengers revenues were up 6.27% YOY to $3.49 billion, while regional revenues increased 4.15% YOY to $777 million. Other revenues also jumped 13.17% to $584 million.

Consolidated yields for the carrier in 2013 decreased to 14.80 cents, down 0.1 % from 14.82 cents in 2012. Passenger revenue per available seat mile (PRASM) also decreased 1.2% from 12.82 cents in 2012 to 12.67 cents in 2013.

The major driver behind the decline in fares and PRASM was the 7.1% increase in capacity as measured in available seat miles (ASMs). As the graphic below shows, Alaska has been extremely aggressive in launching new routes over the past two years, and that aggression has filtered into the unit revenue data.

The tenor of the expansion is also interesting, as Hawaii is no longer a major expansion spot. Alaska appears to have captured all of the “low hanging fruit” or easy to enter and profit in markets in Hawaii, and has now entered a holding pattern of sorts until the competition ramps up with Hawaiian Airlines set to enter secondary West Coast markets using its fleet of 16 Airbus A321neos beginning in 2016.

Alaska Airlines has instead turned to a mixture of long haul transcon markets, and point to point (p2p) routes in the Western United States that don’t touch its main hubs at Seattle or Portland.

In particular, the latter strategy holds some merit given that the traditional market leader on these routes, Southwest Airlines, is grappling with ever rising costs. Furthermore, given the battle brewing with Delta Air Lines in Seattle for 2014, diversifying capacity away from Seattle serves as hedge of sorts.

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It is worth noting that mainline operations in particular were responsible for the consolidated decrease in yields and PRASM, while the carrier’s regional operations saw YOY growth for both metrics. Regional yields increased to 29.20 cents (1.4%YOY), while PRASM increased 3.7% YOY to 23.83 cents. However, given the ever swelling route structure of Delta in Seattle, the highly lucrative monopoly Horizon routes in the Pacific Northwest may soon come under attack.

Turning to expense, Alaska Air Group reported a 5% YOY increase to $4.318 billion. Unlike every other US carrier who has reported financial results for 2013, Alaska’s fuel costs actually increased 1% to $1.46 billion even as consolidated fuel costs per gallon decreased 2.1% to $3.30, down from 2012’s $3.37. However, fuel costs per ASM (a more useful metric given the aggressive capacity growth) fell 5.7% YOY. Employee costs rose as well, with a 4.6% increase in salaries YOY to $1.06 billion. Variable incentive pay rose 19% to 105 million, split between annual performance based incentives and monthly operations based incentives. Aircraft maintenance expenses rose 11.2% while the cost of contracted services rose 10.5%.

Cost per available seat mile (CASM) excluding fuel remained virtually flat at 8.47 cents (8.48 cents in 2012), while overall CASM fell 2.3% to 12.82 cents, reflecting Alaska’s strong commitment to cost control and increased employee productivity. The latter has been particularly successful, as employee productivity at Alaska Airlines has jumped a cumulative 20% since 2006.  And, as an airline in the midst of aggressive expansion, Alaska has a natural depressor for its unit cost figures, because the carrier can amortize fixed costs over an ever increasing number of flights and ASMs.

With regards to CASM, Alaska Airlines is utilizing the same techniques as network carriers the world over, shifting to larger aircraft and reconfiguring those aircraft with more seats. In particular, the shift to standardize the fleet on the 737-800 and 737-900ER will pay dividends in the upcoming tussle with Delta, as the lower CASM will allow Alaska to compete more effectively on fares

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Turning to the balance sheet and cash flow, Alaska ended the year with $1.3 billion in cash and unrestricted securities (short term investments), and lowered its adjusted debt-to-total capitalization ratio to 35%. Alaska is by far the least leveraged US network airline and its balance sheet contains basically no net debt. Alaska Airlines has not yet made its cash flow statement public as of press time, but this space will be updated with operating cash flow and free cash flow figures when they are available.

For the full year, Alaska reported a very strong 16.3% operating margin, including a 10.7% margin in the fourth quarter. However, given that close 28% of Alaska’s capacity is tied to Hawaii and Mexican resort markets (Cabo and Puerto Vallarta in particular), the fourth quarter is stronger for them than most. For calendar 2013, Alaska recorded a record 13.6% return on invested capital (ROIC), its second consecutive year above 13%.

Looking forward into 2014, Alaska Airlines has displayed a clear record of financial success and strength. Moreover, the drivers behind its economic strength are unique; a cocktail of code share partners, low costs, and a fiercely independent brand image.

But 2014 will be a year of unprecedented threats as Delta takes aim at Alaska’s core hub in Seattle. In the long run, Alaska has the financial strength and economic moat to outlast Delta in a war of attrition in Seattle. And thanks to management’s record of consistently returning cash to shareholders, staying independent might be the more lucrative option for Alaska Air Group’s owners. But in the near term, this battle will cause financial pain, as will encroachment onto Delta’s turf in Salt Lake City (Delta has been known to run competitors out of core markets with extremely low fares when necessary). So the question becomes, do Alaska Air Group’s shareholders have the appetite to stomach poor returns over the next few years?

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