Alaska Air Group reported revenue of $2.66 billion in Q2 '22, up from $1.53 billion in Q2 '21, driven almost exclusively by a rise in passenger segment revenue. Operating expenses shot up, driven primarily by an almost 3x rise in fuel costs. This resulted in the operating income falling to $187 million from $549 million in Q2'21. With a slight increase in the outstanding share count, EPS dropped from $3.18 in Q2 '21 to $1.10 in Q2 '22.
Below are key drivers of Alaska Air Group that present opportunities for upside or downside to the current Trefis price estimate.
Fuel Costs % Of Passenger Revenues: Fuel expenses are the largest operating expense incurred by an airline. Alaska's fuel costs as a percentage of its passenger revenues dropped to 31% in 2014 due to the steep fall in global crude oil prices in the year's second half. Further, it fell to 20% in 2015 due to the continued fall in crude oil prices. The number fell further to 15.4% in 2016. However, with the rise in crude oil prices, fuel costs in 2018 jumped to 25%. In 2021, the metric dipped to 23%.
We expect fuel costs as a percentage of revenues to increase gradually over the Trefis forecast period due to strengthening global crude oil prices. If, however, fuel costs % of Passenger Revenues rise and reach 30% by the end of the Trefis forecast period, instead of the current forecast, then there could be a downside of more than 10% to Trefis price estimate for Alaska Air Group's stock.
Alaska's Passenger Yield: Alaska's Passenger Yield decreased from $0.1491 in 2014, due to the pricing pressure from Delta Air Lines and other airlines, to $0.1427 in 2015. In 2016, the number showcased improvement and increased to $0.1449. However, in 2017, the inclusion of Virgin led to a fall in the key metric to about $0.1395. By 2021, the passenger yield had increased to $0.1425.
However, if passenger fares rise more than anticipated - either due to unexpectedly high crude prices or strong growth in demand for flights - and take the yield to $0.168 by the end of the Trefis forecast period, then there could be a potential upside of approximately 10% to Trefis price estimate for Alaska Air Group's stock.
Alaska Air Group was founded in 1985, and it has two principal subsidiaries: Alaska Airlines (Alaska) and Horizon Air (Horizon). Through these subsidiaries, Alaska Air Group provides passenger air service to more than 29 million passengers annually to more than 100 destinations. It also provides freight and mail services, primarily to and within the state of Alaska and on the west coast. Although Alaska Airlines and Horizon operate as airlines, their business plans, competition, and economic risks differ substantially. Alaska operates on longer distance routes using an all-Boeing 737 fleet, while Horizon operates on shorter route networks using an all-Q400 aircraft fleet.
With regard to the airline's service network, Alaska offers extensive north/south service within the western U.S., Canada, and Mexico, as well as passenger and dedicated cargo services to and within the state of Alaska. It also provides long-haul east/west services to Hawaii and many cities in the mid−continental and eastern U.S. This is primarily from Seattle, where the carrier has its largest concentration of departures. However, it does offer long-haul departures from other cities as well.
Horizon Air is the largest regional airline in the Pacific Northwest and contributes 90% of Alaska Air Group's regional revenue passengers. It serves many cities in six states, five destinations in Canada, and two in Mexico.
The US segment is the most valuable to the company for the following reasons.
Alaska Air Group has a dominant position on many west coast routes from Seattle, Anchorage, and Portland. As a result, the carrier enjoys relatively higher pricing power in these markets. It is also relatively free to raise the fee for ancillary heads like baggage and ticket change.
Fuel expenses constitute the single largest cost head for airlines, including Alaska. This makes airlines highly vulnerable to hikes in crude oil prices. For Alaska, fuel costs constitute about 35% of its total operating expenses. Alaska engages in fuel price hedging to reduce its vulnerability to fuel price volatility.
The demand for flights is highly correlated to global economic growth. Thus, a decline in economic growth, or a recession, reduces the demand for flights, which impacts passenger traffic for airlines. On the contrary, steady growth in the global and the US economy grows demand for air travel, allowing airlines to raise their airfares, occupancy rates, and profits.
Many airlines, including Alaska, are figuring out ways to grow their top lines through ancillary heads such as baggage fees, access to onboard WiFi/food/drinks, etc. Accordingly, airlines are investing in enhancing their product offerings, including in-flight WiFi and other entertainment options, improved lounge facilities, and extra-legroom seats.
According to a recent Amadeus/IdeaWorks study, North American airlines collectively produce one of the largest streams of ancillary revenues compared to other regions. Most of the increase is attributable to stronger merchandising efforts by the carriers and the addition of more à la carte services for sale.
During the past decade, low-cost carriers gained a significant market share. Going forward, as travel demand grows, it is inevitable that these low-cost carriers will take a large share of this incremental demand.
The US airline industry has seen many mergers and acquisitions in the last decade, including the five big combinations of US Airways and America West, Delta and Northwest, United and Continental, Southwest and AirTran, and American and US Airways.
The industry's consolidation has improved the profitability of all airlines by restraining the capacity addition by these airlines. Earlier, individual airlines were adding capacity at higher rates to grow their market shares, which resulted in an oversupply of seats, reducing the margin and profits of all carriers.
Going forward, we expect the industry to remain profitable as long as airlines add capacity with discipline.