Why Is Alaska Air Ahead Of Its Peers? – Part 2

In an environment where the top US airlines have been quivering over investor perceived overcapacity, Alaska Air continues to grow, rather strongly. The Seattle-based airline witnessed an increase of more than 18% in its stock price over the last three months, when the rest of its competitors were struggling to convince the market about the fundamentals of their business. In fact the airline has managed to remain resilient recently, even when the global markets started wobbling over fears of yet another recession due to weakness in the Chinese economy and its impact on the rest of the world.

In our previous article, “Why Is Alaska Air Ahead Of Its Peers? – Part 1,” we had discussed some of the quantitative reasons that are driving the airline’s exceptional performance. Just to do a quick recap, we discussed factors such as its diversifying revenue base, focus on operational excellence, and a low cost structure, which influences the airline’s current market price. In this note, Part 2 of the series, we will talk more about the qualitative factors, such as a strong management, generating value for the shareholders, and an investment grade balance sheet, that are keeping Alaska Air ahead of its peers.

Source: Google Finance

We have a price estimate of $81 per share for Alaska Air, which is almost 7% ahead of its current market price.

See Our Complete Analysis For Alaska Air Group Here

A Focused Management

A leader is one who knows the way, goes the way and shows the way. – John C. Maxwell

Source: geniusquotes.org

Alaska Air has a top management that not only knows “what to do” but also knows “how to do it.” How else can one justify the resilience demonstrated by the airline when its leading position in Seattle was threatened by its closest rival, Delta? Though Delta’s invasion into Alaska Air’s home town created a pricing pressure for the latter, it did not unnerve the senior management of the airline. Rather, the management chalked out a well thought out plan to defend its position in the Seattle market, which accounts for more than 60% of the airline’s revenues.

The carrier reallocated some of its Seattle capacity to newer destinations and added non-stop flights to Salt Lake City, where Delta holds a strong position. The airline reached the 1,000 flights-per-day mark in early July with an aim to grow its Seattle capacity 10% by the end of this year. In addition, the airline has invested money on hiring more counter staff and building landing gates in Seattle to strengthen its presence in its home town. All these efforts have enabled the airline to maintain its No. 1 position in Seattle, despite the growing competition from Delta. With the superior managerial skills and expertise of Alaska Air’s senior executives the airline is well placed to overcome such incursions even in the future.

Contrary to this, the top executives of two of its competing airlines – American Airlines and Southwest – publicly commented on expanding their capacity, if needed, to fight competition. This triggered a fear of a potential excess supply of seats in the market, leading to a major stock sell-off by investors.  Most of the top US airlines, including Alaska Air, lost close to 10% of their market cap within a week of these events. However, since the airline’s management refrained from getting its hands dirty in this mess, the airline’s stock quickly recovered, while the counterparts continued to struggle. To further add to the situation, the US Department of Justice (DOJ) launched a probe against the top four US airlines – American, United, Delta, and Southwest – to detect any unlawful price collusion among these airlines. Again, Alaska Air came out clear from this situation and continued to focus on growing its operations. All these events go on to show the credibility of Alaska Air’s management and its contribution in the airline’s progress.

Source: Google Finance

Generating Value For The Shareholders

While some airlines, such as JetBlue and United, continue to shy away from paying out dividends to the shareholders, Alaska Air’s management has been proactively returning cash to its shareholders in the form of dividends and share repurchases over the last couple of years. The airline started distributing dividends in 2013 and has raised the dividend payments from $0.125 per share in 2014 to $0.20 per share in the latest quarter((Second Quarter 2015 Results, 23rd July 2015, www.alaskaair.com)). Consequently, Alaska Air currently has a dividend yield of 1.1% for the trailing twelve months (TTM), which is higher than all its peers. The airline’s willingness to share its growing profits with its shareholders not only highlights the solid fundamentals of the business, but also reinforces investor confidence in the company.

Source: Company Filings, Google Finance

In addition to paying dividends, Alaska Air has constantly leveraged any opportunity to buy back its own shares at attractive prices. In the beginning of this month, the airline authorized a new $1 billion share repurchase plan, which is the airline’s ninth repurchase program since 2007((Alaska Air Group 2Q15 Conference Call Transcript, 23rd July 2015, Seeking Alpha)). The airline has spent more than $1.1 billion in repurchasing approximately 53 million shares, representing about one-third of its total outstanding shares in 2007. The airline plans to return over $550 million to shareholders in 2015, of which it has already returned more than $300 million in the first half of the year. The management’s faith in its own business, reflected in the large repurchase programs, is enabling Alaska Air to attract more investors than its rivals.

Source: Bank of America Merrill Lynch 2015 Transportation Conference

Investment Grade Balance Sheet

Over the years, the Seattle-based airline has been trying to de-lever its balance sheet using its notable cash flows. With constant efforts, the airline managed to bring down its debt-to-capitalization rate from 81% in 2008 to 31% in 2014. This is consistent with the capital structure of S&P 500 Industrials, which range between 25-45%. As a result, the airline has obtained an investment grade credit rating from S&P and Fitch. It is the second airline, after Southwest, to have received this rating. A strong credit rating adds to the credibility of the airline’s operations and makes it, seemingly, a safer bet for the investors.

Source: Bank of America Merrill Lynch 2015 Transportation Conference

In the first half of 2015, Alaska Air generated a net profit of $383 million and operating cash flow of $889 million, almost double compared to a year ago. The management utilized these cash flows to pay down its debt obligations to further reduce the airline’s leverage. The airline lowered its debt-to-capitalization rate from 31% in 2014 to 29% at the end of June 2015. As a result, Alaska Air has become the only airline to have a net interest income, as indicated by the management in its latest conference call. With a stronger and less levered balance sheet, the airline has a potential to deliver potentially less risky returns than its competitors going forward.

Debt-to-Capitalization Ratio Across The Industry

Source: Bank of America Merrill Lynch 2015 Transportation Conference

Having discussed the quantitative as well as the qualitative factors that are driving Alaska Air’s performance, we believe that with a strong and experienced management, which continues to focus on operational excellence and a low cost structure, and believes in returning value to the stakeholders, the airline will continue to outperform its competitors at least in the foreseeable future.

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