Alaska Air Earnings: Profit Growth Accelerates

Alaska Air (ALK 0.72%) was one of the most profitable airlines in the world prior to its late-2016 acquisition of smaller rival Virgin America. However, in the two years following the merger, the company's profitability has plunged.

Over the past year, the Alaska Airlines parent has been working to improve its pre-tax margin to a target range of 13% to 15%. It hopes to do so by capturing merger synergies and implementing new ancillary revenue initiatives that should boost revenue per available seat mile (RASM). The company's second-quarter earnings report -- released on Thursday afternoon -- showed that Alaska Air is making progress toward its goals.

Alaska Air results: The raw numbers

Data source: Alaska Air Q2 earnings release. Chart by author. PP = percentage points. EPS = earnings per share.

What happened with Alaska Air this quarter?

The key highlight of the second quarter was that Alaska Airlines' revenue initiatives finally began to have a significant impact on the company's results. RASM rose 5.2%, coming in slightly above the high end of the guidance range that management had provided three months ago.

On Alaska Air's earnings call three months ago, management indicated that the carrier was on track to reap the full benefit of its various revenue initiatives by the middle of the second quarter. These strong results seem to validate that projection. Additionally, the company noted that fares for last-minute bookings have improved in recent months after being quite weak during parts of 2018 and earlier this year.

Alaska Airlines also did a good job of controlling its costs last quarter. That allowed it to expand its adjusted pre-tax margin by 3 percentage points year over year. This was the first significant margin increase for the company in several years and it powered 31% growth in adjusted net income and adjusted earnings per share.

In recent months, Alaska has also reached new agreements with some of its labor groups. This included uniting its mechanics under a joint contract for the first time since the Virgin America merger. These new labor contracts will increase Alaska Airlines' costs in the short term, but they'll ensure labor peace and may enable future productivity gains.

What management had to say

Alaska Air CEO Brad Tilden was extremely pleased about the company's improved results last quarter. "The three-percentage point improvement in our adjusted pre-tax margin shows that our revenue initiatives and cost management efforts are paying off. We set an ambitious plan and are executing it," he said.

Tilden also emphasized that Alaska Airlines continues to please its customers, which creates the foundation for long-term growth. As he put it: "But what our people really do best is provide genuine, caring service for our guests, and that's why they earned our 12th-straight J.D. Power award this year. ... We're all looking forward to building on this momentum in the months and years ahead."

Looking forward

Alaska Airlines expects its strong unit revenue growth to continue in the third quarter. RASM is on track to rise 2% to 5%, despite somewhat faster capacity growth of approximately 3% (compared to 0.9% last quarter).

Alaska Airlines' unit revenue is growing nicely this year. Image source: Alaska Airlines.

Meanwhile, adjusted nonfuel unit costs will likely rise about 5% this quarter. That includes a $24 million signing bonus and $10 million in increased wages related to Alaska Airlines' new labor agreements. These costs will pressure nonfuel unit costs by more than 2 percentage points in Q3. On the bright side, fuel prices remain below last year's levels, so Alaska anticipates paying $0.12 per gallon less for jet fuel.

Based on the midpoint of Alaska's guidance range, revenue would reach $2.36 billion in the third quarter -- up nearly 7% year over year. Adjusted EPS would rise to around $2.05, compared to $1.91 a year earlier.

This would seem to indicate that Alaska Air's earnings momentum is set to fade. However, it's important to note that the company dramatically outperformed its guidance last quarter. Alaska Airlines also faces some one-time costs in the third quarter, as noted above.

By the fourth quarter, management expects adjusted nonfuel unit costs to decline approximately 1.2% year over year. That would pave the way for a return to strong margin expansion if Alaska Air's recent RASM momentum continues.