How Sensitive Is Alaska Air’s Price To Oil Prices?

by Trefis Team
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Alaska Air Group
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The slump in commodity prices that began in mid-2014 led to a reversal in the profitability of the US airline industry. Since fuel costs are the single largest operating cost for an airline, the sharp drop in oil prices has augmented the earnings of these airlines over the last few years. The airlines, in turn, have utilized the increased profits to revamp their operating fleet as well as balance sheet to return higher value to their shareholders. However, the recovery in crude oil prices over the last few quarters has resulted in a decline in the profitability of these airline companies. In this note, we show how a change in crude oil prices can impact the profitability as well as valuation of Alaska Air (NYSE:ALK) using our interactive dashboard.

Higher Oil Prices Could Pull Down ALK’s Price

Since fuel costs are the major operating costs of an airline, a marginal change in crude oil prices can significantly impact its operating expenses, and, in turn, its earnings. However, airlines are aware of the volatility in crude oil prices, and consequently, hedge a large portion of their annual fuel consumption at lower oil prices in order to maintain their margins.

Based on our analysis and company guidance, we believe that a $1 per barrel rise in the crude oil price could result in a 0.82% increase in Alaska Air’s fuel cost. For instance, if the oil prices jump $5 per barrel higher than our base case estimate of $65 per barrel, it will cause the airline’s fuel expense to shoot up by 4.1% (blue bars). This will cause the airline’s net income margin to drop sharply, resulting in lower earnings per share.

Now, if we assume a P/E multiple of 12x for Alaska Air, we arrive at a price estimate of $59 per share, which is roughly 9% lower than our base case price estimate of $65 per share. Thus, we figure that Alaska Air’s valuation is sensitive to the movement in oil prices.

Do not agree with our forecast? Create your own price forecast for Alaska Air by changing the base inputs (blue dots) on our interactive platform.

 

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