Alaska Air Group Earnings: Signs of a Turnaround Are Appearing

In the first half of 2018, a combination of surging fuel prices and unit revenue declines led to alarming margin erosion at Alaska Air (ALK -1.82%). The company's adjusted pre-tax margin fell from 18% in the first half of 2017 to just 7.5% in the same period this year. As of late July, it expected to face a similar level of margin pressure in the third quarter.

However, Alaska Air's third-quarter results came in much better than management had initially expected. Alaska still reported a significant decline in adjusted earnings per share on Thursday, but its margin pressure is finally starting to subside. Furthermore, the airline expects continued improvement in its revenue and earnings trends in the fourth quarter.

Alaska Air results: The raw numbers

Data source: Alaska Air Q3 earnings release.

What happened with Alaska Air this quarter?

During the third quarter, Alaska Airlines continued to refine its route network with the goal of boosting unit revenue. In 2017, the carrier added a slew of new routes in California to take advantage of its Virgin America subsidiary's strong market position there. In the last couple of quarters, it has reversed course, eliminating underperforming flights. Based on its new route announcements last quarter, Alaska Airlines appears to be refocusing its near-term growth on the Seattle area, where it is the No. 1 airline.

These route network changes are already helping. Revenue per available seat mile (RASM) decreased just 0.1% last quarter, near the top of the carrier's guidance range for a 0% to 3% decline. That compares to a 3.6% RASM decline in the first half of 2018.

Alaska Air also recently doubled down on its efforts to boost ancillary revenue. Earlier this year, the carrier announced a variety of fee and policy changes that are expected to add $150 million in annual revenue by 2019. Just a week ago, it followed most of its competitors by increasing its baggage fees (effective Dec. 5). This move could potentially drive $50 million of incremental revenue in 2019.

What management had to say

Alaska Air executives were pleased with last quarter's improving business trends. However, they are firmly focused on completing the merger integration process related to the company's late 2016 acquisition of Virgin America. This will allow Alaska to get back to the basics of offering friendly and efficient service. Management believes that's the key to returning to earnings growth.

"In the nearly two years since our merger closed, we've now completed approximately 90 percent of our integration milestones," said CEO Brad Tilden. "With that work now behind us, we are doubling down on what we do best -- keeping fares low, delivering leading operational performance and offering top-rated customer service."

Looking forward

Alaska Airlines' revenue recovery is on track to continue in the fourth quarter as the carrier's growth slows and its unit revenue initiatives gain traction. Management projects that RASM will increase 1.5% to 3.5% this quarter.

Alaska Airlines expects to get unit revenue growing again this quarter. Image source: Alaska Airlines.

Even with a return to RASM growth, Alaska Air's pre-tax margin will decline again. The carrier expects to pay $2.37 per gallon for fuel (up from $2.00 per gallon in the prior-year period), while adjusted non-fuel unit costs are on track to rise about 3.2% year over year.

Still, Alaska's fourth-quarter guidance implies perhaps 3 to 4 percentage points of margin erosion on a pre-tax basis. That's much better than the 6.5-percentage-point pre-tax margin decline it recorded in the third quarter and a dramatic improvement compared to the 10.5-percentage-point plunge in pre-tax margin that it experienced in the first half of 2018.

With merger synergies and ancillary revenue initiatives set to give Alaska Air an extra boost in 2019, the airline's turnaround plans finally seem to be on track.