Alaska Air Group (NYSE:ALK) posted strong growth in its first quarter profits driven by solid demand for air travel and its own revenue initiatives such as an increase in ticket change and extra baggage fees. Driven by these factors, the carrier’s first quarter profits rose to $94 million, from $37 million in the prior year period.  These growing first quarter profits are impressive as until a few years back Alaska was posting losses in the first quarter due to its heavy reliance on the state of Alaska and the Pacific northwest, which used to be impacted from the severe winter in these regions during the first quarter. However, over the last few years, to reduce this seasonality in its business, Alaska redirected a significant portion of its capacity to other markets such as Hawaii during the winter months. This enabled the carrier to steadily improve its first quarter profits.
During the quarter, Alaska also hiked its dividend payout from 20 cents a share to 25 cents a share highlighting its strong balance sheet and cash flow from operations.  In our opinion, these growing shareholder returns are reflective of the significantly improved health of the U.S. airline industry.
See our complete analysis of Alaska Air Group here. We are in the process of incorporating first quarter results and shall update our analysis shortly.
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Healthy Demand Environment & Ancillary Revenue Initiatives Lift Alaska’s Top Line
In the first quarter, on support from the solid demand environment, Alaska raised its flying capacity by 4.6% annually. This enhanced its passenger traffic by over 4% annually. The carrier’s passenger yield which is reflective of fares also improved by 2.2% on a year-over-year basis. As a result, Alaska’s passenger revenues grew by 6% annually to $1.04 billion in the first quarter.  Going forward, Alaska plans to continue to raise its flying capacity at similar rates through 2014. Additionally, as the demand for air travel is likely to remain strong through the year, we figure the carrier’s passenger revenues will likely rise in 2014, compared to 2013.
Alaska’s first quarter ancillary revenues also rose by 22% annually to $158 million.  We figure hikes in ticket change fee and extra baggage fee that Alaska implemented late last year were the primary factors behind this strong growth in its ancillary revenues. This strong growth in both passenger and ancillary revenues raised the carrier’s total revenues by 8% annually to $1.2 billion.
Alaska’s first quarter profits also benefited from lower year-over-year fuel prices.
Threat From Delta’s Expansion In Seattle
However, with the first quarter performance behind Alaska in the coming months will face increasing competition from Delta in the Seattle market. Delta is expanding its service in Seattle to build the city as its international gateway to Asia. To feed its international passenger traffic from Seattle, Delta in recent months has added domestic service connecting Seattle to cities such as Anchorage, Fairbanks, Las Vegas, Los Angeles, Portland, San Diego, San Francisco and San Jose.
From Alaska’s perspective, this expansion is threatening as the carrier is heavily dependent on the Seattle market. Last year, around 60% of Alaska total passengers either embarked from or disembarked at Seattle.  Additionally, Seattle-Anchorage, Seattle-Los Angeles, Seattle-San Diego, Seattle-Las Vegas and Seattle-San Francisco, where Delta is expanding its service, are the leading revenue generation routes for Alaska. During its first quarter earnings presentation, Alaska said that Delta’s expansion at Seattle has created excess capacity. Though eventually Alaska anticipates this excess capacity to be absorbed by the growing demand for flights, we figure in the meantime, this excess capacity will exert pressure on Alaska’s fares and yields. However, to Alaska’s credit, it has a lower cost structure compared to Delta, so it can drive down its fares more profitably to attract customers. Nonetheless, Delta’s expansion will increase pressure on Alaska’s yields.
On its part, Alaska is reallocating some of its capacity to new destinations out of Seattle such as Tampa, Detroit, New Orleans, Albuquerque, Baltimore and Cancun. This expansion will likely strengthen Alaska’s position at Seattle as frequent fliers are usually attracted to a carrier that connects maximum destinations out of a city. Alaska is also reallocating some of its capacity to new markets outside of Seattle to reduce its dependence on the city. In June, Alaska will start flying from Salt Lake City to seven cities in the west. We figure these measures will offset some of the impact from Delta’s expansion, but Alaska will also take time in achieving load factors (percentage of seat occupied by passengers in a flight) and yields that are near its system average on these new routes. Thus, in the meantime, we could see some pressure on the carrier’s load factors and yield, which will likely weigh on its top line growth.Notes: