Why We Think Alaska Air Is Worth Much More

It has been a great year for the US airline industry. With oil prices plummeting to multi-year lows, US airlines have been making huge profits and their stocks have reached all-time highs over the last few quarters. Amidst all this, Alaska Air (NYSE:ALK) is focusing on enhancing its operational performance and leveraging its efficient cost structure to maintain industry leading margins and outperform its peers. Furthermore, the airline has been successfully venturing into new markets to tap the rising air travel demand and expand its market share. Consequently, we believe that the Seattle-based airline will continue to grow in the near future on the back of its outstanding operational performance, aggressive yet targeted capacity expansions, and cost control initiatives, in addition to the cost savings from lower fuel costs.

We have a price estimate of $84 per share for Alaska Air, which is 3% ahead of its current market price. In this note, we justify our stance on the company’s current valuation.

See Our Complete Analysis For Alaska Air Group Here

Outstanding Operational Performance

Alaska Air has been consistently working over the years to improve its operational performance in order to deliver high standards of service to its customers. The airline has an on-time rate of 86.7%, which is one of the highest in the industry. In addition, the carrier has the lowest cancellation rate year-to-date 2015 compared to its competitors, a key metric watched by industry experts to analyze an airline’s performance.

Source: Cowen Transportation Conference, September 2015

Based on its exceptional performance, the airline has been recognized as “highest in customer satisfaction among traditional carriers” by J.D. Power for eight consecutive years. The satisfaction level of customers is clearly evident from the growth in the airline’s mileage members over the last 5 years.

Source: Cowen Transportation Conference, September 2015

Since the airline’s management intends to continue to enhance its operational performance, we expect Alaska Air to continue to be preferred by its customers for its outstanding service and enjoy a premium over its counterparts.

Efficient Cost Structure

Unlike its peers, Alaska Air is not relying solely on the weak crude oil prices to boost its profits, rather, it is working towards reducing unit costs on a sustainable basis. For this, the airline has been striving to improve its efficiency and productivity through various cost control measures. For instance, the airline has been replacing its older, smaller 737-400 airplanes with 737-900 and 737-MAX airplanes to gain efficiency from flying larger and more-fuel efficient aircraft. Moreover, Alaska Air has enhanced its overall productivity by more than 3.5% annually over the last 7 years, which translates into cost savings of approximately $11 million annually. Consequently, the airline has significantly reduced the gap between its own cost structure and that of the legacy carriers such as American Airlines, Delta Air Lines, and United Continental Holdings.

Source: Cowen Transportation Conference, September 2015

Thus, we anticipate that its efficient cost structure will allow Alaska Air to continue to deliver market leading margins even in the future.

Growth Prospects

Alaska Air considers itself to be a growth company and has grown by more than 7% annually over the last 20 years. While the top four US airlines continue to restrict their capacity growth due to fears of an oversupply of seats in the market, Alaska Air targets to increase its system capacity by 10.5% for the full year 2015, which is among the highest capacity additions in the industry. Further, the airline has diversified its operations in markets which have a strong demand and is exiting the ones which are not economically sustainable in the long term. For instance, the carrier has ventured into 21 new markets so far in 2015 and aims to launch operations in 4 new markets in the last quarter of the year.

Source: Cowen Transportation Conference, September 2015

Apart from this, Alaska Air has introduced a number of new revenue streams, the latest one being the preferred seating program. In addition to enhancing customer satisfaction, this program is expected to generate additional revenue of $15 million annually for the airline. While it may seem to be a small amount, it will add a sizeable amount to the airline’s overall revenue in 2015 and beyond.

Keeping the above arguments in mind, we believe that Alaska Air is set to outperform its peers in the future driven by its exceptional operational performance, efficient cost structure, and rapid capacity expansions.

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