Aggressive Capacity Expansions May Be A Double-Edged Sword for Alaska Air

Alaska Air Group (NYSE:ALK) is slated to announce its first quarter operating results on Thursday, 23rd April 2015, along with Southwest (NYSE: LUV) and United (NYSE: UAL). The airline continued to aggressively add capacity during the first quarter to cope  with the stiff competition from Delta (NYSE: DAL) in Seattle. Overall, the airline is expected to record an increase of more than 9% in its passenger traffic, driven by capacity expansion of close to 11% during the March quarter ^[1]. Despite the increased competition, the analysts anticipate Alaska Air to earn a net profit of $1.10 per share in this quarter on the back of strong capacity additions and lower fuel prices.

We currently have a price estimate of $69 per share for Alaska Air, 6% ahead of its current market price.

See our complete analysis for Alaska Air Group here

Rapid Capacity Additions Will Boost Top Line But Could Weigh On Its Margins

Alaska Air has been expanding its flying capacity at a fast pace for more than a year,  not only to grow its market share but also to defend its leading position in Seattle, where Delta is aggressively adding capacity to build its international hub. Based on the traffic results for March, Alaska Air’s mainline capacity is expected to grow by 11.4% on a year-on-year basis, the highest rate of capacity addition by any major US airline in the quarter. Consequently, the airline’s passenger traffic is estimated to increase by more than 9% on a year-on-year basis. However, this will lead to a fall in Alaska’s occupancy rate (percentage of seats occupied by passengers in a flight) from 84.7% in March 2014 to 83.4% in March 2015 ^[1]. Despite this, the analysts forecast the airline to post quarterly revenue of $1.27 billion, up by almost 4% from the same quarter last year.

While the rapid capacity expansions will boost the airline’s top line growth, we expect them to create a pricing pressure for the Seattle-based airline. Alaska forecasts its unit revenue (amount collected from each passenger per seat for a mile of flight) to drop by approximately 6% year-on-year during the latest quarter due to a 1.5% headwind created by the severe winter weather in first quarter of 2014 and increased competition in its key markets. Besides, the airline expects its unit costs (excluding fuel costs and special items) to remain flat during the quarter. Hence, the airline’s bottom line is expected to suffer due to this pricing pressure. The impact of falling unit revenue may be, however, offset by the prevailing low oil prices during the first quarter. As of December 2014, Alaska Air had hedged close to 50% of its first quarter fuel requirements through call options. Thus, we estimate the airline’s average fuel costs to decline significantly, improving the airline’s net income for the quarter.

Going forward, the airline plans to continue expanding its Seattle capacity at a rate of 10% during the year to battle the capacity expansions by Delta. The airline aims to increase its overall capacity at a high rate of 8% in 2015, which will continue to create pricing pressure for the airline. (Read: Alaska Air’s Rapid Capacity Ramp Up Will Likely Impact Its Margin & Yield)

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1. Alaska’s Operating Results for March, 2 April, www.alaskaair.com [↩] [↩]