Why Alaska Air Group Is a 2014 Short Candidate

Alaska Air Group, (NYSE: ALK  ) , the leading carrier in the Pacific Northwest, has been one of the strongest performers in the airline industry in the last five years. But its business model, which has helped it post massive gains since the beginning of 2009, now faces serious threats.

ALK Chart

Alaska Air Group 5 Year Price Chart, data by YCharts

Alaska's 2013 results were pressured by capacity growth on the West Coast (NYSE: LUV  ) . Routes to Anchorage saw a particularly significant step-up in capacity this spring. But competitive capacity growth will really take off in 2014, led by Delta Air Lines (NYSE: DAL  ) and Southwest Airlines (NYSE: LUV  ) . Meanwhile, Alaska is planning to add a variety of new routes in Salt Lake City, a market that Delta dominates.

Alaska faces significant new competition on numerous routes.

This increase in competition will probably cause margin contraction and a reduction in EPS for Alaska Air Group starting in Q2 2014 and ramping up in Q3. These headwinds make Alaska a potential short candidate for 2014.

Delta's Seattle buildup
The first set of pressures comes from Delta's growth in Seattle. Since the beginning of October, Delta has announced four sets of new routes from Seattle, Alaska's top hub. All of Delta's new routes are already served by Alaska, and on some of them Alaska has a near-monopoly position.

Nearly every large West Coast city, including Portland, San Francisco, San Jose, Los Angeles, Las Vegas, and San Diego, is receiving new or expanded Delta service to Seattle in 2014. These "trunk" routes make up a significant proportion of Alaska's total capacity.

Delta Air Lines is adding service from Seattle to nearly every large West Coast market.

Alaska will likely need to implement heavier discounts in 2014 in order to keep its planes full on routes where industry capacity is rising strongly. With so many routes facing new competition, Alaska's unit revenue is likely to decline next year.

A second threat
Moreover, Delta is not the only carrier expanding on Alaska's turf, although it represents the biggest threat. Southwest is also boosting service on the West Coast in competition with Alaska. For example, next June, Southwest will start new flights from San Diego to Portland, Seattle, Orlando, and New Orleans. The first three routes will all be in competition with Alaska.

Southwest is a particularly dangerous competitor in San Diego, because it is already the largest carrier there, with nearly 100 daily departures. Southwest is also expanding in Portland, Alaska's second-largest hub, with new or increased service to Chicago, Baltimore/Washington, and Houston, as well as San Diego.

Compounding the damage?
While it faces threats on its own turf in 2014, Alaska is also embarking on an expansion in Salt Lake City, one of Delta's hub cities. Alaska's rapid growth in Salt Lake City appears to be the result of a "tit-for-tat" exchange with Delta.

Thus, following Delta's third announcement of new short-haul routes from Seattle in early December, Alaska Air Group stated that it would start new service from Salt Lake City to Portland, San Jose, Los Angeles, and San Diego.

That did not have the desired effect, as Delta soon responded with a fourth expansion of short-haul service from Seattle. But Alaska quickly doubled down by announcing three more routes from Salt Lake City: Las Vegas, San Francisco, and Boise.

Delta is likely to defend its turf in Salt Lake City just as vigorously as Alaska plans to defend its turf in the Pacific Northwest. As a result, none of Alaska's new Salt Lake City routes are likely to produce high profit margins. Alaska may find that its attempts to send a message to Delta merely compound the damage to itself.

Foolish conclusion
As one of the highest-margin airlines in the U.S., Alaska Air Group has become a natural target of competitors' expansion plans. The company long benefited from its strength in peripheral parts of the West Coast, which were not strategically vital to other airlines.

But the major airlines are now scouring the country for the last few profitable expansion opportunities. Alaska is therefore likely to confront significantly higher competition going forward than it has in recent years.

This will put pressure on Alaska's profit margin in 2014 and beyond, and will likely cause EPS to stagnate or decline. Investors should look to sell shares in Alaska while the stock is trading near all-time highs -- and the company could even be a short candidate for 2014.

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