Alaska Airlines outlines a decade of restructuring

While other legacies were touting their achievements in their long and frustrating march toward a profitability they have yet to achieve, Alaska’s message to the Bank of American Merrill Lynch Global Transportation conference was that it was already there. Indeed, one of the few profitable airlines in the US, Alaska Air Group has been through a decade of restructuring, that did not include bankruptcy and which transformed from a north-south carrier in the hotly competitive and low-yield west coast market to a much more diversified carrier that includes both transcontinental and Hawaiian routes.

“We’ve spent the better part of a decade restructuring,” said AAG Chair Bill Ayer. “Started in 2003, it was designed to benefit the customer and employees, but left out of the equation for way too long has been investors. In fact, they have been left out of the equation in most of the airline industry. Now we are focusing on that. We are now producing a high-value product for our customers and secure jobs for our employees and we are working on a good outcome for investors that targets a 10% return on invested capital over the entire business cycle".

He added, "While some years may fall short, we expect others to exceed that. We want to reach an 8% weighted average cost of capital. We’ve made a big improvement in all aspects of the business to the point we have industry-leading results in every metric you look at. We are optimistic we will be able to achieve that goal. The path is to improve revenue and reduce costs and be very careful about capital. We are now at a 4.4% pre-tax margin but that is not bad considering the challenges faced in 2009 and compared to the rest of the industry.”

In 2001, Alaska Air Group was a very high-cost airline and that was one of the first things the carrier began to address. The company, in the 1Q2010 led the industry in free cash flow at 34% of 12 months trailing revenues, but is now working to adjust that down to between 25% and 30%, Ayer said, adding that he could put an additional USD350 million to work to pay down debt.

Lower capex ahead

He admitted the company’s leverage is still high compared to the rest of the industry at 75%. “Somewhere in the 60s is a better place to be considering the uncertainty of the economy and the volatility of the industry,” he said. “With re-fleeting behind us, we plan to spend the next few years with lower capital spending. Our profitability, coupled with lower cap ex will generate free cash flow.” 

He also announced on Tuesday that the company was buying back up to USD50 million of its common stock using cash on hand. "This programme allows us to continue enhancing shareholder value through the repurchase of outstanding shares, while preserving our strong cash balance," he said. "Today's announcement is consistent with the company's practice of repurchasing shares opportunistically and underscores our commitment to providing a reasonable return to investors."

The airline’s strategy is to concentrate on its strengths in the Pacific Northwest building both a schedule and network utility that contributes to the bottom line. It has moved from MD-80s in a fleet replacement program that capitalizes on the efficiencies of a single-aircraft fleet in the B737. It has 54 B737-800s and its regional subsidiary, Horizon is in the process of shedding its CRJ-700s in favor of the Bombardier Q400. Ayer indicated that it will go back into the market to sell the regional jets now that the market is improving.

Diversifying into east-west

In the past 24 months, it has introduced 26 new city pairs diversifying out of its north-south tilt to east-west. “We see a pick up in our trans- and mid-con markets,” he said. “Hawaii is up 11% although it was planned at 15%. West Coast is now 70% of our route structure, down from 100% in 2000.”

For 2011, the company is continuing to work on reducing overhead. Not only has it reduced the absolute dollar of overhead spend, he said, Alaska’s restructuring has created a culture in which employees are spending money as if it were their own, "very conservatively". It still has a ways to go on overhead, however, said Ayers, adding that, just as with the entire industry, airport costs are a concern.  

Ayer signaled that there is a renewed emphasis on Horizon and the company was taking the opportunity of new leadership under former AAG CFO Glenn Johnson to examine the regional carrier which, he said, has not improved as much as Alaska. “There is no reason they can’t operate at a 10% ROIC,” he said, adding that pilots pay was not at industry standards. “There is also the maintenance costs which have risen in the past year.”

Alliances and mergers

It is also not interested in cutting a single alliance in favour of connecting to everyone. Its major partners are now American and Delta. Less exposed both to the international and business markets, Ayer indicated that such alliances were extremely important to give passengers the global reach they need.

When questioned about growth, Ayer said the airline was being careful that any new capacity comes from a foundation of profitability. “You can’t grow yourself into profitability,” he said. “Hawaii made a lot of sense out of Anchorage, Seattle and Portland and we found that market changes meant Oakland, San Jose and Sacramento were underserved after Aloha and ATA went bankrupt. Demand is driving our choice there. There is excess demand and we will take advantage of that and the 737-800 is well suited to other islands. So we are going non-hub airport to the out islands.”

On consolidation, Ayer said a merger would be a question of shareholder value and whether it would be optimised. “Right now I think we are on the right path with 10% return on ROIC as a goal and growing organically and we think that should result in the best returns for shareholders,” he said. “That is our thesis and plan and if that isn’t the case, we’ll find a better alternative.”

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