Last quarter, Alaska Air's (ALK -1.85%) adjusted net income soared 31% year over year as the Alaska Airlines parent beat its unit revenue guidance and did a good job of controlling its costs. This strong performance demonstrated that the company's plan to use a variety of revenue growth initiatives to boost its profit margin is succeeding.
Last week, Alaska Airlines tweaked its forecast for the third quarter, indicating that profitability is tracking ahead of expectations again. This is a great sign that the company's momentum is intact. With Alaska Air stock still trading for less than 11 times its projected 2019 earnings -- a bargain valuation -- there's plenty of upside for investors if the company continues performing at a high level.
Another unit revenue forecast increase
In late July, Alaska Air estimated that revenue per available seat mile (RASM) would increase 2% to 5% in the third quarter. That's identical to the guidance it provided at the beginning of the second quarter, but it would represent a slight deceleration from the 5.2% RASM gain the company ultimately reported last quarter.
Last Wednesday, Alaska Airlines narrowed its revenue guidance range for the quarter. It now expects to post a 3% to 5% RASM increase this quarter. This shows that the carrier is still seeing strong demand in most of its markets, which is particularly comforting given that some other airlines have had to cut their forecasts recently.
Lower fuel costs pave the way for strong earnings growth
As part of its recent guidance update, Alaska Airlines also reduced its fuel cost outlook for the third quarter. Its quarterly economic fuel cost per gallon is now on pace to come in at $2.15: down from $2.33 a year earlier and below the airline's initial estimate of $2.21.
Alaska Airlines is sticking with its original forecast for nonfuel unit costs to rise 5% this quarter. However, that includes $24 million in one-time signing bonuses related to new contracts for several work groups. Excluding that one-time item, Alaska's guidance implies a nonfuel unit cost increase closer to 3%.
Furthermore, even with nonfuel unit costs up 5% year over year, the carrier is on track to post another big profit increase in the third quarter. Based on the midpoint of its new RASM forecast, Alaska Airlines' adjusted earnings per share should come in near the current average analyst estimate of $2.19. That would be up 15% compared to its adjusted EPS of $1.91 in the third quarter of 2018.
There's plenty of upside for investors
Alaska's profit growth is likely to accelerate dramatically in the fourth quarter. The company expects a significant drop in unit costs during that period, and it will continue to benefit from the revenue growth drivers that have helped it over the past several quarters.
Looking further ahead, Alaska Airlines expects to reap another $105 million of annual merger synergies by the end of 2021. It is also exiting numerous underperforming routes over the next several months -- and moving others from year-round to seasonal service -- while adding new routes and extra capacity in markets where it has a stronger competitive position. That should help it continue to post solid unit revenue gains next year.
As a result, Alaska Airlines is well positioned to post double-digit earnings growth in 2020 (and perhaps also in 2021). Barring a big spike in oil prices or a recession, this should enable it to reach its long-term pre-tax margin target range of 13% to 15% by 2021 at the latest. That would drive EPS to $8 or more, making Alaska Air stock seem like a bargain at its recent trading price near $63.