Alaska Air’s Rapid Capacity Ramp Up Will Likely Impact Its Margin & Yield

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Alaska Air’s (NYSE: ALK) plan to ramp up its Seattle capacity by 10% in 2015 will likely weigh on its load factor and passenger yield. Alaska’s strategy is an attempt to defend its dominant market position in its largest hub, Seattle, which has been challenged by aggressive capacity addition from Delta (NYSE: DAL). While Delta, in the past, relied on Alaska’s passenger traffic to feed into its connecting flights through code-sharing agreements, its decision to build Seattle as its core hub has resulted in direct competition between the two carriers. In this article, we discuss how Delta’s decision will impact Alaska’s performance.

Our current price estimate for Alaska Air stands at $69, roughly 5% higher than  its market price.

See our complete analysis for Alaska Air Group

Delta’s Capacity Expansion So Far

Delta’s move comes from its aspirations to expand its offering in the Asian market, which is being viewed as a key growth market by airline companies globally. While the San Francisco market is dominated by United (NYSE: UAL), and the Los Angeles market is highly fragmented, Seattle was an obvious choice for Delta, given that it is the closest mainland U.S. city to Asia. Thus, Delta’s decision to establish Seattle as its international gateway to Asia is well founded.

As part of its strategy, Delta has introduced flights from Seattle to all major cities in the Western U.S., growing its Seattle operations from 34 peak-day departures to 15 destinations at the beginning of 2014, to 85 peak-day departures to 26 destinations at present. Delta is also using marketing techniques such as billboards, airport signage, in-flight magazine editorials, and community involvement to strengthen its presence in the Seattle market. As a result, Delta’s market share in Seattle has increased to 20%, second only to Alaska’s market share, which stands at about 55%. Delta aims to grow its Seattle capacity to about 150 peak-day departures to 35 destinations across three continents, over the next couple of years. This will increase Delta’s capacity overlap with Alaska from 41% in 2014 to 50% in 2015.

Alaska’s Strategy to Battle Competition In Seattle

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Seattle is a key market for Alaska Air, as it draws more than 60% of its passengers to and from Seattle. In response to Delta’s expansion, Alaska is growing its capacity. Last year, the carrier raised Seattle capacity by 4% year-on-year. The carrier reallocated some of its Seattle capacity to newer destinations such as Tampa, Detroit, New Orleans, Albuquerque, Baltimore, and Cancun. Alaska also added seven new non-stop routes out of Salt Lake City, where Delta holds a strong position. In an effort to preserve its market share in Seattle, Alaska plans to further grow its capacity by 10% this year in Seattle. Some of the new routes that Alaska plans to launch include Seattle to Milwaukee, Oklahoma City, and Washington D.C. (Dulles).

Alaska’s CFO Brandon Pedersen, during the JP Morgan Aviation, Transportation & Industrials Conference held on 3rd March, elaborated about Delta’s aggressive capacity expansions and its impact on the flying capacity in Seattle. According to him, Delta would have roughly 3,200 seats a day out of Seattle by July this year as opposed to about 700 in the prior year. He also highlighted that there are 13 overlapping city pairs out of Seattle which could impact Alaska’s pricing power. However, he continues to be confident about Alaska’s ability to compete with the increasing competition, through its low cost structure and operational efficiency.

Impact of Rapid Capacity Ramp Up On Alaska’s Yield

While the two carriers remain code-share partners, the share of Delta in Alaska’s revenue has declined from 4.8% in 2013 to 3.6% in 2014. Both the airlines have also cut down elite benefits for passengers flying with each other, and are also offering double miles promotions on many routes to drive passengers away from one another. While Alaska’s top line is not significantly dependent on Delta’s share, this is indicative of the intensity of competition among the two carriers.

While Alaska has managed to maintain its leading position in Seattle, Delta’s capacity expansion has weighed on Alaska’s pricing ability and consequently its unit revenue. Alaska’s passenger yield (amount collected from each passenger for a seat per mile of flight), which measures air fares, remained relatively flat last year, compared to rising yield experienced by other carriers in the industry.

The carrier’s domestic occupancy rate (percentage of seats occupied by passengers in flights) also fell in 2014 due to Delta’s rapid expansion. While the carrier aims to attract passenger traffic through its preferred seating initiative, and improvements in its frequent flier program in 2015, we anticipate that Alaska’s stance to add further capacity this year will continue to create pressure on its yield and occupancy rate.

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