Alaska’s Revenue, Profit Could Rise Despite Increased Competition From Delta

Alaska Air Group (NYSE:ALK) will announce its fourth quarter and full year 2014 results on Thursday, January 22. The carrier is coming off good results in the first three quarters in which it posted healthy growth in revenue and profit, despite increased competition from Delta in Seattle. In the fourth quarter, we expect Alaska to continue to grow its revenue and profit on gains from capacity expansion and cost cuts. However, like in the previous quarter, Alaska expects a decline in its unit revenue – the amount collected from each passenger per seat for a mile of flight – in the fourth quarter.

We currently have a price estimate of $53 for Alaska, around 15% below its current market price.

See our complete analysis of Alaska here

Aggressive Capacity Expansion Will Lift Top Line

In the fourth quarter, Alaska expanded its flying capacity by nearly 11% annually. ^[1] This was the highest rate of capacity addition for any major U.S. airline in the fourth quarter. We figure Alaska is aggressively expanding its capacity not only to grow its market share but also to defend its Seattle hub from Delta.

Since the start of 2014, Delta has rapidly expanded its services at Seattle in an attempt to establish the city as its international gateway to Asia. The network carrier started 2014 with roughly 38 daily departures from Seattle, but it has now grown that number to 93 peak-day departures to 32 destinations. By mid 2015, Delta plans to further expand its daily Seattle departures to 120 (peak-day), serving 35 destinations. ^[2] This sudden expansion by Delta at Seattle is compelling Alaska to expand its own network out of the city so as to prevent frequent fliers from shifting to Delta. Frequent fliers typically prefer to register with an airline that has a larger network out of their base city. This helps them earn more miles and rewards. In addition, Alaska has started serving new markets such as Salt Lake City in an attempt to diversify from Seattle, further boosting its capacity growth. Alaska’s capacity expansion in the fourth quarter raised its passenger traffic by nearly 10% annually, which will grow its fourth quarter top line. ^[1]

That said, aggressive capacity expansion is coming at a cost to Alaska. The carrier’s pricing ability and consequently its unit revenue is being impacted. Last quarter, Alaska’s unit revenue fell by 1% year-on-year, meaning the carrier was able to collect less money per mile of flight from each passenger. ^[3] In comparison, the unit revenue of other major U.S. airlines has been rising on support from the strong demand environment. In the fourth quarter, Alaska expects its unit revenue to fall by 2.5% annually due to rapid expansion. ^[1] This fall in unit revenue will weigh on Alaska’s fourth quarter profit.

Cost Cutbacks Could Lift Profit

On the bright side, Alaska has been able to significantly lower its costs over the past few years, so it can withstand a marginal decline in its unit revenue. To lower its operating costs, the carrier has subcontracted many services to third-party vendors. The carrier has also increased the share of alaskaair.com in its total bookings to save on distribution costs, and it has lowered maintenance costs by replacing older, less efficient airplanes in its fleet with new airplanes such as the Boeing 737-900ER. Benefits from these cost-side measures should enable Alaska to grow its fourth quarter profit, despite lower unit revenue.

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1. Alaska’s form 8-K filing for December traffic report and Q4 investor update, January 9 2015, www.alaskaworld.com [↩] [↩] [↩]
2. Delta adds Denver, Boise, Sacramento, Ketchikan and Sitka from Seattle, November 19 2014, www.delta.com [↩]
3. Alaska’s 2014 Q3 earnings form 8-K, October 23 2014, www.alaskaworld.com [↩]