On Thursday, Alaska Air Group (ALK -0.58%) became the latest airline to post a hefty loss for the third quarter: traditionally the most profitable part of the year for many airlines. Despite the weak headline numbers, Alaska's Q3 performance represented another step toward returning to health. Between its solid balance sheet, improving demand trends, and abundant cost-cutting opportunities, the Alaska Airlines parent is poised for a strong earnings recovery over the next several years.
Q3 by the numbers
Alaska Airlines continued to restore capacity during the third quarter after making sharp cuts in response to the COVID-19 pandemic earlier this year. That said, capacity remained significantly lower than year-ago levels last quarter -- down 55.1% -- compared to a 74.6% year-over-year decrease a quarter earlier. Alaska has also continued to block middle seats, which isn't counted in these capacity reduction figures.
Considering how few seats were available for sale, Alaska's 70.7% revenue decline (to $701 million) last quarter doesn't seem so bad. This beat the average analyst estimate by more than 3%. That result also marked a significant improvement relative to the airline's 81.6% revenue decline in the second quarter.
Alaska Air reported an adjusted net loss of $399 million for the third quarter: $3.23 per share. That was somewhat worse than the average analyst estimate of $3.01, but again better than its Q2 adjusted net loss of $439 million ($3.54 per share). Perhaps more importantly, daily cash burn averaged about $4 million last quarter: in line with the company's June performance and down from a peak of around $13 million near the end of March.
During Alaska Air's Q3 earnings call, management noted that demand has been improving gradually month by month. Executives particularly highlighted rising demand for travel to Hawaii, now that the state has removed a 14-day quarantine requirement for visitors who receive a negative COVID-19 test result within 72 hours of departure.
The recent trend of steady improvement means that cash burn will likely slow further in the fourth quarter. Management did abandon its prior goal of reaching cash breakeven by year-end, largely because Alaska Airlines has decided to continue blocking middle seats until early January. That effectively prevents the airline from achieving the load factor it would need to break even. On the other hand, this move could give more customers the confidence to fly in the months ahead -- which will make them more comfortable booking additional flights.
Falling short of the year-end breakeven goal is not a big deal, all things considered. Alaska Air has one of the strongest balance sheets in the industry. In fact, management noted that the company ended last quarter with net debt and lease liabilities of just $1.7 billion: in line with its net debt at the beginning of 2020. As of last week, it had $5.5 billion of liquidity, providing plenty of room to maneuver. And once the low-fare airline fully unblocks middle seats sometime in 2021, it should reach cash breakeven in short order.
Time to play offense
Before the pandemic hit, Alaska Airlines was focused on leveraging its strength along the West Coast to grow with new routes connecting the biggest cities in the region to smaller markets in the West. In recent months, it has continued this strategy -- with a particular focus on "sun and snow" leisure routes -- announcing a slew of new service to mountain and warm-weather getaway destinations.
Alaska Airlines is also making rapid progress on a program to eliminate $250 million of structural costs. Meanwhile, it has confirmed that it will join the oneworld global airline alliance on March 31, 2021, which will open up new sources of revenue. Finally, with 42 leases for Airbus jets expiring between now and 2023, the airline is poised to capitalize on the current airplane glut either by negotiating significantly lower lease rates or by replacing those planes with more-efficient new jets that it can buy at favorable prices.
Together, these moves should enable Alaska Air to earn higher margins once demand fully returns. That in turn could drive a robust recovery for Alaska Air stock.