Over the past year, Alaska Air's (NYSE:ALK) management team has spent a lot of time talking about how the company is set to improve its performance, but there weren't many visible signs of a turnaround. Alaska Airlines led the industry in terms of profit margin in 2016, but its profitability has quickly plunged to mediocre levels since then.
However, in the past few months, Alaska Air's profit improvement initiatives have finally started to gain traction. Last week, the company increased its third-quarter outlook for the second time. This should give investors more confidence that Alaska will stabilize its profitability soon.
The initial outlook was subpar
Back in July, Alaska Airlines projected that revenue per available seat mile (RASM) would slip 0% to 3% during the third quarter. Meanwhile, the carrier expected its non-fuel unit costs to rise about 4.9%, and its average fuel cost to surge 28% to $2.30 per gallon from $1.80 per gallon in the prior-year period.
This forecast caused the average analyst earnings-per-share estimate for Q3 to plunge from $1.98 to $1.55 between mid-July and mid-August: down from adjusted EPS of $2.24 a year earlier.
The projected EPS decline was particularly disappointing because Alaska Air -- like all of its U.S. peers -- is benefiting from a big drop in the federal corporate tax rate this year. The guidance implied an adjusted pre-tax margin decline of about 10 percentage points compared to the company's Q3 2017 result of 21%.
Guidance has been getting better
Last month, Alaska Airlines modestly improved its third-quarter outlook, calling for RASM to decline no more than 2% and non-fuel unit costs to rise 4.1%. (On the flip side, the carrier bumped its fuel cost estimate up to $2.32 per gallon.)
It raised its guidance even further in an investor update filed on Oct. 12. The carrier now expects to report a tiny 0.1% to 0.2% RASM decline for the third quarter, along with a relatively modest 2% increase in non-fuel unit costs. Its fuel cost projection inched up again, to $2.33 per gallon.
Alaska Airlines attributed its better revenue outlook to "improved close-in pricing in many of the markets we serve." It said that solid underlying cost control, lower incentive pay, and some shifts in the timing of expenses all contributed to the improvement in its cost forecast.
Based on the company's updated guidance, Alaska Air is on track to post a pre-tax margin of approximately 14% for the third quarter. EPS is likely to come in between $1.85 and $1.90, well ahead of analysts' current estimates and not much worse than what analysts had been expecting prior to Alaska Air's disappointing earnings report in July.
Further improvement likely in the fourth quarter
Alaska Airlines' unit revenue trajectory should continue to improve in the fourth quarter. First, the carrier is set to slow its own capacity growth again, as it eliminates some underperforming routes and laps the introduction of a slew of new routes last fall.
Second, the carrier has tightened the availability of award travel during peak periods. This should reverse most of a 1.5 percentage point unit revenue headwind from award travel that Alaska suffered in each of the last two quarters.
Third, Alaska has implemented a variety of fee increases and policy changes, which should boost ancillary revenue starting this quarter.
Looking ahead, there is even more upside in 2019, as Alaska Airlines will soon introduce its version of basic economy fares. It will also capture the bulk of the merger synergies from the Virgin America deal next year. Slower growth -- with a focus on the Seattle region, where Alaska Airlines is the leading carrier -- should also support unit revenue growth. Indeed, all signs point to a budding turnaround for Alaska Air.