Alaska Air's Earnings Preview: 5 Themes to Watch

Alaska Airlines Boeing 737-900 image by InSapphoWeTrust under Creative Commons license.

Alaska Air Group (NYSE: ALK  ) has enjoyed several quarters of increased net income and a fairly pleasing rise in its stock. Last November, I recommended that investors take a look at ALK and its ability to climb higher. The company hasn't disappointed, and it reports its second-quarter 2014 earnings next week, on July 24. Let's review five key themes investors should follow in the upcoming release, to ascertain whether the company will continue to ascend.

Traffic should propel another positive comparison
Last quarter, Alaska Air Group posted record first-quarter net income of $94 million, driven by strong customer demand and incremental revenue from its many ancillary revenue strategies. Traffic increases in each of the first three months of the year averaged about 3.75% over the prior year's quarters.

In the second quarter, monthly operational reports provided by the company reveal that positive traffic comparisons have continued. Traffic for this April, May, and June exceeded prior-year results by 4.3%,4.8%,and 5.3%, respectively, for an average increase during the quarter of 4.8% over 2013. Outpacing previous traffic is a bedrock for positive earnings; of course, ticket pricing and the amount of ancillary (non-ticketed) revenue the company generates for each mile flown will also determine the quarter's performance.

Speaking of "other" revenue ...
Last year, Alaska Airlines took two important steps to boost its ancillary revenue. The airline raised prices on its checked baggage (while extending its popular Baggage Service Guarantee, or BSG, program), and it modified its affinity (co-branded) credit card agreement with Bank of America. The result has been a marked increase in ancillary revenue, tracked in the "other-net" line item in the company's revenue category on its income statement.

During the first quarter of this fiscal year, the airline booked $158 million of ancillary revenue, a 22% increase over the prior-year quarter. Shareholders should expect an increase in the second quarter of roughly 20%, again versus the prior year. That would amount to at least $166 million in "other-net" revenue, which would result in a 5% sequential increase from Q1 2014.

ROIC and variable incentive pay should rise
Two of the less direct metrics that are important to follow for Alaska Airlines are return on invested capital, or ROIC, and variable incentive pay. ALK's ROIC has increased steadily over the past few years, as it has decreased its debt and moved to greater net ownership of its planes. Last quarter, at the end of March, the company's trailing-12-month ROIC increased to 14.8%, from 13.4% in the trailing 12 months ended March 31, 2013. Look for this metric to stay within the 14% to 15% range.

Another metric to watch is variable incentive pay. This is additional compensation contingent on the company's meeting its performance goals, and it's open to all employees. Last quarter, Alaska's variable incentive pay amounted to $25 million, or about 2% of total revenue, for an increase of 19% over the prior year. An expansion of the same magnitude in quarter two would be an indication that the company continues to enjoy significant productivity and cost efficiencies from its workforce.

The Delta factor
So far, Alaska Air Group has weathered Delta's transition from code share partner to bona-fide competitor with patience and proactiveness. During the company's first-quarter earnings call, CFO Brandon Pedersen broke down Delta's increased traffic in Seattle -- Alaska's home base -- into three categories. The first, wide-bodied jets flying to international destinations, has little ultimate impact on Alaska's operations. The second, traffic going to Delta hubs and major cities where Seattle doesn't have much presence or native routes, is similarly negligible to ALK. The third, true overlap of routes, is where Alaska may feel the pinch from new Delta capacity.

Investors will be keen to understand the impact of Delta's incursion on second-quarter results from this third category. Also of interest will be any information on the increasing importance of American Airlines as a code share partner, a new source of revenue that provides a buffer to Delta's parries. We'll analyze both in detail post-earnings.

Impact of new routes
One final key theme will be to gauge the effect of the many new routes Alaska Air has added in the last year as it shifts capacity to respond to Delta's aggressiveness. The company has introduced routes while dispensing with non-profitable routes without a significant change to its fleet, thus optimizing its profitability. Ironically, ALK has Delta to thank for having to take such a close look at its current air map. Last month, the airline announced six new domestic routes, of which five will originate from Salt Lake City -- one of Delta's smaller hubs. 

Overall, this should be another strong quarter for Alaska Airlines. But investors will also be concerned with the company's outlook for the rest of the year, especially in the context of Delta's competitive threat and ALK's new route additions. We'll follow up with a detailed earnings recap after the 24th of this month.

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