Alaska Air in USD58 million profit, pausing to review operations to drive efficiencies

Now that it has had a few good quarters and its Hawaii service is maturing, Alaska Air Group is pausing to examine every facet of its business to drive more efficiency and maximize revenues. AAG subsidiary Horizon is also undergoing a top down evaluation to determine the future of its branded network.

Horizon reorganisation

Newly installed Horizon President Glenn Johnson reported on his vision for the regional carrier, saying that, although the company has many strengths, its weakness lies in its inability to deliver on profitability. “While we are making progress, we can and must achieve a 10% margin,” he said. “For the 12 months ended 30 Jun our margin was 5.1%. To continue closing the gap and accelerating the pace of improvement, the Horizon leadership team is evaluating the current business model to determine how best to go about making Horizon a financial success and what changes may be necessary to accomplish this.”

Johnson pointed to the programs begun by former President Jeff Pinneo who retired recently. Indeed, Chair and CEO Bill Ayers took a moment to praise Pinneo for the work he did in Horizon’s turnaround. That work includes completing the aircraft transition as it sheds the 13 CRJ 700s and adds eight Bombardier Q400s, leaving it with a 48-aircraft Q400 fleet.

“When finished, we will reduce our invested capital by USD100 million between aircraft and inventory, thus saving USD9 million per year in expense,” he said.

He also said he is considering outsourcing maintenance just as Alaska has done, something he called very successful. It already has bids from US-based maintenance vendors and confirmed significant savings by outsourcing.

“We are now engaged with the International Brotherhood of Teamsters to determine whether we can realize the same level of savings within our current framework,” he said. “If not, we will transition to a highly experiences US vendor for both heavy and specialised maintenance.”

Horizon recently reached an agreement in principle with the IBT for a new pilot contract and is now working with the union to translate that into a tentative agreement that can be voted on by the pilot group.

“We continue to look at all areas where Alaska and Horizon have similar functions,” he said. “While we will remain separate entities we are actively evaluating which operational areas we can consolidate.”

Turning to brand considerations, Johnson noted Horizon is a hybrid airline, flying 45% of ASMs for Alaska under a capacity purchase agreement and 55% under its brand flying. Horizon then gets a pro-rate of the fare for passengers who connect from its branded operations to Alaska.

“Over the last decade an increasing portion of our flying has been dedicated to Alaska and our aircraft are well suited for complementing or substituting for Alaska on certain routes,” he said. “That flying coupled with past and possible future expansion into geographic areas that are not traditionally Horizon locales, such as California, Arizona and Mexico, is causing us to take a fresh look at the costs versus benefits of maintaining the Horizon brand from an external perspective and we will be discussing this with our board during the third quarter.”

2Q2010 review

Alaska Air Group CFO Brandon Pedersen reported that, on an adjusted basis, Horizon earned a profit of USD8.2 million, saying it was the best since 2006. However, its net loss was USD1.2 million, a substantial swing from the USD6 million profit posted in the year-ago quarter.

The regional took a pre-tax charge of USD3.4 million on one CRJ it is subleasing to another carrier. “We plan to sublease four more during the third quarter and expect to take further charges in the USD7-9 million range,” he said. “We will likely incur additional costs on further disposals, furloughs and other expenses.”

Analysts would say the evaluation is long overdue, but it has been a few years since they hammered on Alaska Air Group to rid itself of the regional airline. In that time, the company has made steady progress in repairing itself financially and made consistent contributions to the bottom line. One of its major problems was its regional jet was acquired to diversify its capacity purchase business but its deal with Frontier was ended leaving it with an aircraft it did not really need at a time when there were few CPA RFPs out there. It was then faced with trying to sell the aircraft at the cusp of the recession and is only now finding success with offloading them.

However, its branded flying, unique in the traditional US regional airline industry, always produced a question mark. While it can be compared to the Republic Airways Holdings hybrid, that is significantly different, since Frontier is a successful low-cost carrier. It is possible the solution will be to expand the capacity purchase agreement or to close down the branded side of the house.

Total operating revenues for the subsidiary rose 8.4% to USD171.1 million while expenses increased at a faster pace of 14.2% to USD167.5 million. Horizon’s yield rose 6% to 37.01 cents in the second quarter as PRASM grew 7.8% to 20.20 cents. CASM increased 13.5% to 20.11 cents as operating expenses grew from USD146.7 million to USD161.5 million. ASMs grew only 0.6% to 833 million. It reported operating income of 3.6 million down significantly from the year-ago period which was USD11.2 million. Horizon’s full year capacity will be down 1-2% as consolidated capacity rises 4%.

Air Group results

The Air Group reported operating expenses increased 11.5% during the second quarter of USD866.5 million. Revenues of USD976.4 million up 15.7%. Air Groups other revenues reached 66.8 million, up 8.6%

Citing higher load factors, improved pricing and good cost control, Pedersen said the Alaska Air Group posted an adjusted net profit of USD85 million for the second quarter compared to the USD26.5 million in the year-ago period. He noted it was a USD55 million increase after taxes and USD91 million on a pre-tax basis yielding a consolidation pre-tax margin of 13.8%, well above the 10% goal the carrier has set for its return on invested capital.

It is also a 12-month return of 8.3% on a USD3.5 billion base of invested capital, he said. “Depending on how the year shakes out – and this is in no way guidance – we may very well hit our goals of a 10% return. But our goal is a 10% return over the entire business cycle so we have to exceed the 10% in the good years to offset the weaker years in the cycle.”

Pedersen noted that the carrier originally estimated that its baggage fees would add USD70 million to the coffers, but, in its first year, the airline collected USD98 million and on a per-passenger basis, including bag fees, it received USD11.13 during the first half. He also reported that the 16-June change in the structure of its baggage fees is producing USD30 million in annual incremental revenues.

It finished the quarter with USD1.3 billion in cash and short term investments. Cash as a percent of 12 months trailing revenue rose to 35%, the strongest in the industry. The company is considering how to reduce that to between 25% and 30%. During the quarter the company completed its USD50 million share repurchase program and the board authorized a new program, also at 50 million.

Alaska Airlines results

Mainline yield jumped 6% to 13.85 cents while PRASM rose 11.6% to 11.49 cents. CASM rose 5.9% to 11.30 cents on a 4.4% increase in capacity to 6.1 billion. Mainline operating expenses rose from USD624.3 million in the year-ago period to USD690.9 million in Q2-2010. Load factor rose 4.2 points to 83%. Alaska also spent USD83.1 million on purchased capacity, a 22.7% increase. Other revenues came in a 26.9 million, a 9.7% increase.

 “This has been a great quarter and we have achieved a record pre-tax profit of USD128.1 million compared to USD44 million in the second quarter of 2009,” said Alaska President Brad Tilden. “That results in a quarterly pre-tax margin of 14.7% compared to 6% last year. Mainline passenger revenue was up USD100 million or 17% on a passenger revenue increase of 11.6% and a 4.4% increase in capacity. We experienced a four point increase in load factor and a 6% improvement in yield driving by both bag fees and ticket prices.”

PRASM was up 11% in April, 13% in May and 11% in June comparing very favorably, he said, with that of the domestic industry of 10, 14 and 19%, respectively. “We outperformed the industry by nine points in the second quarter of 2009 so we are very pleased we have kept pace, especially since we added a lot of low-RASM flying in long, stage-length markets like Hawaii. Passenger unit revenue for the second quarter 2010 versus 2009, we were up 6% and the industry was down 2% so we outpaced the industry by eight percentage points.”

Tilden reported that the airline was launching new markets including Seattle-St. Louis, Los Angeles-San Jose, Portland-Honolulu, San Diego-Maui, Portland-Kona. These new routes and others have achieved the company goal of diversifying its revenue base and reducing the seasonality of the business.

When asked if its impressive margins is likely to attract increased competition, Tilden indicated the answer is part of the strategic plan currently under review which includes the carrier's market position, what it plans over the next two to five years and how it can continue to position itself as a good value proposition for all stakeholders. “Our principal is to make sure we have the answer to any low-cost carrier who might come after those margins,” he said. “We will continue to enhance those margins, perhaps by pushing up load factor a little from the 86% and considering how high fares can go and still be considered of value to our customers. That’s been the story of Alaska and Horizon over the last decade – looking for ways to increase efficiency and offer fares that offer value and a good return.”

Ayer added that part of its success is being so responsive to customers who are surveyed as to their needs. “We can move a little faster than bigger carriers,” he said. “We can really address the customer value notion by working to improve the value the customer perceives on Alaska and Horizon.”