Alaska Air Group Earnings: A Turnaround Takes Shape

For most of 2017 and 2018, Alaska Air's (ALK -1.89%) profitability was plunging due to a combination of falling unit revenue and soaring fuel costs. Alaska's adjusted pre-tax margin reached 22.3% in 2016, including the results of Virgin America, which it acquired near the end of that year. Its adjusted pre-tax margin then fell to 16.6% in 2017 and plummeted by another 9 percentage points year over year through the first three quarters of 2018.

However, Alaska Air took a big step toward stabilizing its pre-tax margin last quarter. Furthermore, the reduction of the federal corporate tax rate allowed it to post a modest year-over-year increase in its adjusted earnings per share.

Alaska Air results: The raw numbers

Data source: Alaska Air Q4 earnings release. Chart by author. EPS = earnings per share.

What happened with Alaska Air this quarter?

During the fourth quarter, Alaska Airlines implemented some key strategic moves designed to improve its profitability.

First, it dramatically slowed its capacity growth rate -- from 6.7% in the first nine months of 2018 to just 1.1% last quarter -- by cutting various underperforming routes. This included ending its routes from Dallas Love Field to New York's LaGuardia Airport and Washington, D.C.'s Reagan National Airport and leasing out the corresponding slots at LaGuardia and Reagan National to Southwest Airlines.

Second, Alaska Airlines made a pair of important changes to its fees and policies. In November, it rolled out "Saver" fares -- its version of the basic-economy tickets that many airlines have introduced to appeal to the most price-sensitive travelers. In early December, it followed that up by raising its checked baggage fees, following similar moves by most of its key competitors.

Alaska Airlines captured only a small portion of the revenue upside from these fee and policy changes during the fourth quarter. Nevertheless, revenue per available seat mile (RASM) returned to growth in a big way, jumping 5.2%, exceeding management's initial outlook. This enabled Alaska to slow its pre-tax margin erosion to barely more than 1 percentage point year over year and post a slight increase in adjusted earnings per share (EPS).

In conjunction with the earnings release, Alaska Air also announced that it will raise its quarterly dividend by 9% in 2019, to $0.35 per share.

What management had to say

Over the past year, Alaska Air executives have repeatedly expressed their desire to complete the Virgin America integration process as quickly as possible so that the company can focus on the basics again and eventually regain its position as one of the most profitable airlines in the world.

CEO Brad Tilden is happy with Alaska's progress in this respect and confident about the company's outlook. "In 2018, we achieved the vast majority of our integration milestones and passed through an inflection point in our financial performance," he stated.

Looking forward

Alaska Air's turnaround is set to gain steam in 2019. For the first quarter, management expects RASM to rise 2.5% to 4.5%. This is a solid forecast, considering that numerous airlines have noted recently that the government shutdown and the timing of Easter are putting downward pressure on unit revenue this quarter.

Alaska Airlines' solid unit revenue growth is set to continue this quarter. Image source: Alaska Airlines.

On the cost side, adjusted nonfuel unit costs will likely rise 4.5% to 5% year over year in the first quarter, due to the timing of maintenance events and a big jump in regional capacity. (Regional jets have higher unit costs than mainline planes.) However, fuel costs are on track to decline by about 4% per gallon, offsetting some of this cost inflation.

The net result is that Alaska Airlines' pre-tax margin will likely expand this quarter. (The exact amount of margin expansion will depend on where unit revenue falls relative to management's current forecast -- and whether oil prices go up or down from here.)

Furthermore, unit cost trends are on track to improve over the course of 2019. Meanwhile, merger-related revenue synergies will ramp up as the year progresses and the Easter shift will give RASM an extra boost in Q2. Thus, Alaska Air's turnaround momentum could continue to build over the next few quarters.

Check out the latest Alaska Air Group earnings call transcript.