Why Have We Revised Alaska Air’s Price Estimate To $98 Per Share?

Alaska Air’s (NYSE:ALK) stock price has been on an upward trajectory since the middle of last year. The rate of ascension in the stock price gathered pace in late November 2016, rising roughly 40%. This momentum in Alaska’s stock price can be understood by the airline’s resilience in key metrics and Warren Buffet’s investment in the airline sector at the time. Furthermore, the stock price was helped by the diminishing yield pressure on the U.S. carriers in the domestic markets. Talking more about the recent fourth quarter 2016 results, revenues were up significantly at 11% y-o-y to $1.5 billion. Compared to the legacy carriers and small cost carriers, it was the only airline to report such significant growth in its top line. Despite growing its capacity at thrice the size of the industry, Alaska was able to use it efficiently, as is reflected in the two percentage point increase in the company’s load factor. Consequently, since July’16 to date, Alaska’s stock price has almost doubled.

In line with the company’s most recent earnings and the path it has laid down for future earnings growth, we have revised our price estimate for Alaska to $98 per share. Below we present some of the key reasons supporting the upward revision of the company’s valuation:

Capacity Growth

Alaska Air has historically grown its capacity the most as compared to its peers. The first quarter of 2016 saw the carrier’s capacity up as much as 12.9% y-o-y, while the second quarter saw it up as much as 11.2%. Even as the headwinds related to unit revenues became sticky, and most other carriers started trimming their capacity, Alaska continued to expand it. Consequently, the third and fourth quarter of 2016 saw a growth of 8%-10% in terms of average seat miles. The company maintained that the unit revenue headwinds were related to macroeconomic conditions, rather than excess capacity in the company’s system. It was proved right when it saw the fall in unit revenues in the fourth quarter 2016 limited to -0.9% y-o-y. Going forward, the company has decided to follow the trend of relative moderation in capacity growth, which is still far more than its peers, at an average of 7% y-o-y growth.

Promoting Efficiency

The company has been able to cap its expenditure on heads other than fuel quite successfully in 2016. While Q1’16 saw a decline of -1.2% y-o-y in unit costs, Q2’16 was even better at -3.7% y-o-y. The only quarter to see growth in unit costs was the third quarter, likely due to the impact of higher wages and rents. In Q4’16, the balance was restored, with unit costs falling again at -0.4% y-o-y. This resulted in the full year unit costs to decline -0.8%, impressive given the performance showcased by peers. However, the company’s fuel costs increased almost 12% y-o-y in the last quarter.  To combat this and the increasing fuel costs, which are likely to affect the company’s bottom line negatively, Alaska is working on reducing fuel consumption while upgrading its fleet to promote efficiency and reduce maintenance and service expenditure.

Acquisition Of Virgin America

One of the primary objectives behind Alaska’s acquisition of Virgin America is to expand Alaska Air’s footprint in the West Coast, more specifically California, and to strengthen its competitiveness against the top four U.S. airlines. In the last 10 years, from 2005-2016, Alaska Air has expanded its transcontinental presence, such that, it gets 18% of its total revenues from these routes now. This has occurred alongside capacity expansion, whose pace has exceeded that of the industry over the last few decades.

In line with this, Alaska has announced the inauguration of a number of new flights across the country, starting at cities on the West Coast. One of the more notable launches are the flights to Newark from three different cities on the West Coast, namely, Portland, San Diego, and San Jose. This launch has been facilitated by the Federal Aviation Administration’s recent decision to ease “slot” restrictions. Previous capacity controls at the airport made it extremely difficult for airlines to add new flights at the airport, where United controlled the vast majority of the so-called takeoff and landing slots.

Further, the new flights from San Diego, San Jose, Seattle, Portland, and Los Angeles will allow Alaska Air to establish its presence on the West Coast more firmly.

Introduction Of A Premium Class

In 2017, Alaska expects to launch a dedicated premium class product on its 737s and E175s. It will upgrade some of its main cabin seats to premium economy seats. The new seating program will not only provide additional legroom and more space between seats, but also greater overhead cabin storage space and features like power sockets for each seat. Following is a glimpse of how the 737s will be reconfigured to adjust for the launch of premium seating.

The move is expected to accrue an additional $70 million to Alaska’s revenues in 2017, which will increase to $80 million in 2018.

Have more questions about Alaska Air (NYSE:ALK)? See the following links:

• Alaska Air Higher After Impressive Performance In Q4’16
• What Are Some Of The Latest Developments At Alaska Airlines And How Will They Benefit The Company?
• Why Is Alaska Air Betting Big On California?
• A Look At Alaska Air’s Network Expansion Across The West Coast
• Airlines And The Federal Minimum Wage
• How Did Alaska Air Perform Operationally In October?

Notes:

1) The purpose of these analyses is to help readers focus on a few important things. We hope such lean communication sparks thinking, and encourages readers to comment and ask questions on the comment section, or email content@trefis.com

2) Figures mentioned are approximate values to help our readers remember the key concepts more intuitively. For precise figures, please refer to our complete analysis for Alaska Air Group

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