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Delta Air Lines' Challenge to Alaska Air Keeps Growing

By Adam Levine-Weinberg - Oct 25, 2015 at 9:40AM

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The legacy carrier is adding 10 more destinations from Seattle between now and the beginning of May.

As recently as 2013, Delta Air Lines (DAL 1.90%) operated just 40 daily departures in Seattle. However, the company has been rapidly building a hub in Seattle since then, reaching a new high of 128 daily departures this summer.

Delta's sudden growth spurt in Seattle has put pressure on hometown airline Alaska Air Group (ALK 2.80%). Alaska is still top dog in Seattle -- its main hub -- with more than 250 daily departures and growing, but it no longer dominates the market as it did just a few years ago.

Last week, Delta announced the latest step in its plan to expand its new Seattle hub. This will keep the pressure on Alaska. But Alaska Airlines has thrived in the past few years in spite of (or perhaps because of) the increased competition from Delta, and it will probably continue its success for the foreseeable future.

Delta's plans for the next year
On Monday, Delta announced that it will add four daily round trips from Seattle to John Wayne Airport in Orange County, Calif. The new flights will begin next May 1.

Delta has 10 new routes launching in Seattle in the coming months. Photo: The Motley Fool.

This comes on top of nine other previously announced new routes starting between now and next May. These include transcontinental flights to Boston and Orlando, leisure-oriented routes to Kona and Cancun, and a handful of new regional destinations. Together, these new routes will give Delta more than 140 daily departures in Seattle next summer.

It's no surprise that Delta is adding more flights in Seattle. The Seattle market is key to Delta's strategy for serving Asia. Moreover, the company's management appears to be pleased with the strength of demand there. Delta President Ed Bastian stated earlier this month that domestic unit revenue in Seattle was roughly in line with the domestic average in Q3, despite a 24% capacity increase.

Alaska Airlines shakes it off
I'll admit that in 2013, I was skeptical about Alaska Airlines' ability to maintain its above-average profit margin in the face of rising competition from Delta. However, it hasn't missed a beat.

The new competition from Delta may have pushed Alaska to go ahead with some profitability-enhancing initiatives. Most notably, it has added seats to most of its planes since 2013 and is replacing older 144-seat jets with 181-seat jets to reduce unit costs. Alaska also increased its baggage and change fees in late 2013. It signed a new, more lucrative co-branded credit card agreement. Most recently, it started selling extra-legroom seats.

The results have been spectacular. Alaska Airlines is not just earning record profits -- it has become the most profitable company in the airline industry.

Despite the tough competition, Alaska is earning industry-leading profits. Photo: The Motley Fool.

Alaska's revenue per available seat mile fell 4.4% year over year last quarter, a steeper decline than its biggest domestic competitors have experienced. Yet it still posted a record adjusted pre-tax margin of 29.2% in Q3 (and 22.8% for the past 12 months). For comparison, among the four airlines that dominate the U.S. industry, Delta and Southwest Airlines posted the best pre-tax margins last quarter, at about 20%.

Is Alaska Airlines bulletproof?
Given its stellar performance in the face of Delta's growth in Seattle, Alaska Airlines looks pretty much untouchable. On the other hand, it helped that Delta's growth started from a very small base and that other carriers pulled back in Seattle as the market became more competitive.

Additionally, Alaska may be running short of new major cost-cutting or revenue-generating opportunities. Its fleet renewal project still has a way to go, though. Between now and the end of 2017, Alaska will retire its last 27 older Boeing 737s, replacing them with new 737-900ERs, which have 26% more seats but cost just 2% more to operate.

Given these factors, Alaska Airlines should be able to maintain its stellar profitability based on the growth plans that Delta has disclosed thus far. Last year, Delta suggested that it hoped to reach 150 daily departures in Seattle by 2017, which would only require high-single-digit growth for the next two years.

However, Delta also requested 30 gates at Seattle-Tacoma International Airport in late 2014. That would be overkill for 150 daily departures. With 30 gates, Delta could operate up to 240 daily departures in Seattle.

If Delta grows beyond 200 daily departures in Seattle within the next few years, the sheer volume of capacity growth in Alaska's main market could put significant pressure on its profit margin. Delta could also potentially lure more corporate clients away as its network expands, thanks to its broad international footprint.

Nevertheless, Alaska Airlines is starting from a very strong position. Even in the worst-case scenario where Delta continues growing rapidly, I expect Alaska to adapt and remain one of the most profitable airlines in the U.S. -- though perhaps not as profitable as it is today.

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Alaska Air Group, Inc. Stock Quote
Alaska Air Group, Inc.
$41.17 (2.80%) $1.12
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Delta Air Lines, Inc.
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