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Alaska Air's Q3 Guidance Improves Again

By Adam Levine-Weinberg - Updated Oct 14, 2019 at 9:12AM

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After initially scaring investors with a forecast calling for profit growth to slow in Q3, the West Coast airline is now on track to post another quarter of 30%-plus earnings growth.

Back in July, Alaska Air (ALK -0.79%) reported stellar results for the second quarter. Adjusted earnings per share soared 31% to $2.17, thanks to a 5.2% increase in revenue per available seat mile (RASM) and solid cost control.

Investors didn't celebrate this strong earnings report, because at the same time, management provided guidance implying that earnings growth would slow dramatically in the third quarter. Fortunately, Alaska Airlines has raised its forecast twice since then. This has put it on track to report another excellent quarter later this month.

Guidance improves twice

Alaska's initial forecast for the third quarter called for a solid 2% to 5% increase in RASM. However, the airline also projected that nonfuel unit costs would rise by about 5%. Management did expect fuel costs to fall to $2.21 per gallon from $2.33 per gallon in the prior-year period, but that benefit was to be partially offset by a decrease in fuel efficiency (related to the growth of Alaska Air's regional jet operations). As a result, this initial outlook implied only modest margin expansion.

Alaska Airlines' forecast improved last month. The airline raised the low end of its guidance for RASM growth to 3%. It also reduced its fuel cost estimate from $2.21 per gallon to $2.15 per gallon.

An Alaska Airlines plane flying over clouds

Alaska Air's Q3 earnings outlook has improved dramatically since July. Image source: Alaska Airlines.

On Thursday, Alaska Airlines boosted its guidance once again. It now estimates that RASM rose between 4.3% and 4.5% year over year. Additionally, the company lowered its nonfuel unit cost outlook, calling for a 3.4% to 3.7% increase in that metric. It also reduced its average fuel price estimate to $2.13 per gallon and reported that fuel efficiency deteriorated less than expected last quarter. Finally, Alaska reduced its estimate for nonoperating expense by $9 million, due to one-time gains from the sale of certain securities.

Earnings sailed higher in the third quarter

Taking all the elements of Alaska's updated forecast into account, the airline's revenue likely rose 8% last quarter, reaching $2.39 billion. Meanwhile, adjusted pre-tax income is set to come in around $419 million. That would be up about 35% from $311 million in the third quarter of 2018, largely thanks to approximately 3.5 percentage points of pre-tax margin expansion.

Adding to investors' good fortune, Alaska Air also reduced its effective tax rate estimate for the third quarter in its recent guidance update. The net result is that adjusted EPS is on track to reach approximately $2.60: up 36% from $1.91 a year earlier and even higher than the $2.37 that analysts had been expecting before Alaska released its disappointing Q3 guidance in July.

This once-mighty airline is regaining its momentum

Several years ago, Alaska Airlines routinely ranked among the most profitable airlines in the world. However, its profitability plunged between 2016 and 2018 due to a combination of rising fuel prices, increased competition, and inefficiencies related to integrating Virgin America, a smaller airline that Alaska acquired in late 2016.

Alaska Airlines has finally picked itself up off the mat this year, as merger synergies have risen and the airline has capitalized on its other revenue initiatives. Earnings will almost certainly skyrocket again in the fourth quarter, due to another big drop in fuel costs and an expected year-over-year decrease in Alaska's nonfuel unit costs. (Analysts are calling for EPS to jump to $1.39 from $0.75 a year ago.)

Merger synergies should continue to grow in 2020 and 2021, driving further margin expansion for Alaska Airlines. Looking further ahead, the airline will also benefit as the expensive aircraft leases it inherited from Virgin America start to roll off. Alaska will have the option to renew the leases at lower rates, buy those aircraft, or replace them with new, more fuel-efficient models. Whichever path it picks will be beneficial for Alaska's unit costs.

Finally, by the end of this year, Alaska Air will have paid down most of the debt it took on to finance the Virgin America acquisition. That will enable it to increase its dividend again and start buying back stock at a faster rate. This should add to the stock's upward momentum in the years ahead.

Adam Levine-Weinberg owns shares of Alaska Air Group. The Motley Fool recommends Alaska Air Group. The Motley Fool has a disclosure policy.

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