Alaska, jetBlue and Southwest cost projections; good in the short term but long term challenges loom


Just as the large three global US airlines - American, Delta and United - work to contain their unit costs, their rivals Alaska, jetBlue and Southwest are committed to keeping their respective unit costs in line as the current revenue environment in the US remains weak.

The latter three airlines face different cost dynamics in the future. Alaska is attempting to embark on a merger with Virgin America, which will inevitably create some cost pressure as the full integration gets under way. Southwest is in the middle of complex pilot and flight attendant negotiations, which makes predicting its cost performance in the near- to mid-term difficult. At some point jetBlue will also conclude a new pilot contract that will affect its cost structure.

Cost performance results for Alaska, jetBlue and Southwest for 2Q2016 and the full year look reasonably favourable, although Alaska has refined its 2016 targets slightly, driven in part by increases in performance-based pay. But its costs should remain competitive compared with its peers, and solidly lower than those of the larger network carriers.

  • Alaska, jetBlue, and Southwest are focused on keeping their unit costs in line as the US revenue environment remains weak.
  • jetBlue had the largest unit cost decline in 1Q2016, while Alaska and Southwest recorded smaller decreases.
  • Southwest is estimating a 2% increase in unit costs for 2Q2016, driven by accelerated depreciation expense from the early retirement of its Boeing 737 Classic fleet.
  • Alaska has refined its 2016 unit cost guidance to a decrease of 0.5%, citing changes in performance-based pay and higher minimum wage requirements.
  • jetBlue estimates its 2016 unit costs to range from flat to a 1.5% increase, and has revised its capacity growth projections downward.
  • Labor negotiations and consolidation pose potential cost pressure for Alaska, jetBlue, and Southwest in the near to medium term.

jetBlue bests its 1Q2016 cost estimates, while Alaska cites its high employee productivity

jetBlue posted the largest unit cost decline in 1Q2016, compared with Southwest and Alaska. Its unit cost - excluding fuel, profit-sharing and related taxes - fell 3.6%. Alaska and Southwest recorded a drop of 0.5%.

Alaska, jetBlue and Southwest unit cost performance 1Q2016

Airline Unit cost in USD Percentage increase/decrease
Alaska USD8.51 cents 1.2% decrease
jetBlue USD7.67 cents 3.6% decrease
Southwest ISD8.15 cents 0.5% decrease

jetBlue's 1Q2016 unit cost performance was better than previous guidance issued by the airline, which ranged from flat cost inflation to a 2% decrease. Company executives stated that jetBlue had benefitted from a milder winter that resulted in fewer de-icing events. The airline also posted lower salaries and wages expense than originally forecast, and benefited from a move in advertising expenses to future quarters.

Alaska posted a 1.2% drop in its unit cost excluding fuel (but including profit-sharing). The company singled out its divisional leaders for managing their respective budgets and attaining productivity goals. Offering a measure of the company's productivity, Alaska executives stated in Apr-2016 that the company's figure for passengers per full time employee measured 1.8%.

Southwest also cited milder weather as a driver for its 0.5% drop in unit costs year-on-year during 1Q2016, as well as spend on projects that will shift later into the year.

Southwest and Alaska suffer cost pressure from depreciation in higher performance pay

For 2Q2016 Southwest is estimating unit cost growth (excluding fuel, profit-sharing and special items) of 2%. The company estimates that 1ppt of the increase is driven by accelerated depreciation expense, stemming from the early retirement of its Boeing 737 Classic fleet. The remainder of the inflation of costs is driven by the timing of advertising and technology investments.

In early 2016 Southwest stated that it planned to accelerate the retirement of the Classics by YE2018, instead of in 2021. After failing to reach an agreement with pilots for segmented flying of the aircraft, Southwest further revised its retirement timeline to 3Q2017.

Southwest Airlines fleet summary as of 16-Jun-2016

Aircraft In Service Inactive On Order*
Total: 720 15 276
Boeing 737-300 108 11 0
Boeing 737-500 8 4 0
Boeing 737-7 0 0 30
Boeing 737-700 485 0 0
Boeing 737-700(ETOPS) 2 0 0
Boeing 737-8 0 0 170
Boeing 737-800 117 0 76

See related report: Southwest enjoys revenue benefits from credit card deal; labour issues force early 737 Classic exit

The cost of accelerated depreciation of the Classics is also driving Southwest's forecast of a 1% rise in unit costs for 2016.

Alaska, jetBlue and Southwest unit cost guidance for 2Q2016 and full year 2016

Airline 2Q2016 guidance Full year 2016 guidance
Alaska 1% decrease 0.5% decrease
jetBlue 0.5% decrease to 1.5% increase 0% to 1.5% increase
Southwest 2% increase 1% increase

Southwest's unit cost for 2015 fell 2% year-on-year, compared with a 0.7% drop for Alaska and a 0.5% rise for jetBlue.

Alaska, jetBlue and Southwest 2015 unit cost performance

Airline Unit cost in USD Percentage increase/decrease
Alaska USD8.30 cents 0.7% decrease
jetBlue USD7.51 cents 0.5% increase
Southwest USD7.93 cents 2% decrease

Originally Alaska projected a 1% drop in its 2016 unit costs, but has refined that guidance to a decrease of 0.5%. The company explained that it had changed its performance-based pay (PBP) plan to increase participation levels for supervisors and managers. "These are incredibly important roles, and our board wanted to have their PBP participation better reflect their level of responsibility," stated the Alaska CFO, Brandon Pedersen.

Alaska also explained that it had understated the cost of third-party regional expense in its initial guidance. The company has a wholly owned regional subsidiary, Horizon Air, but also has a contractual flying agreement with SkyWest, which operates Bombardier CRJ700s and Embraer 175s on behalf of Alaska.

The company also stated that new minimum wage requirements in certain markets; they "are having a greater impact than we initially modeled", said Mr Pedersen. The minimum wage in Seattle, which is home to Alaska's headquarters and largest hub, is being gradually increased to USD15 per hour over a number of years. The pay raises starting taking effect in 2015.

jetBlue estimates that its 2016 unit costs should fall into a range of flat to a 1.5% increase. The company recently revised its 2016 capacity guidance downward to 8% to 9.5% growth, from previous estimates of a rise of 8.5% to 10.5%.

Previously, jetBlue has concluded that some capacity reductions could be harmful to its margin performance, but explained that its decision to reduce its growth projections was a result of its ongoing assessments of fuel and revenue environments. Fuel costs have been inching upwards while unit revenues for nearly all US airlines are forecast to drop in 2Q2016. jetBlue is forecasting a unit revenue decline of 7.5% to 8.5% in the second quarter.

See related report: jetBlue Airways works to reverse negative unit revenues as investors continue pressure for rewards

Alaska, jetBlue and Southwest face cost unpredictability driven by labour and consolidation

Alaska, jetBlue and Southwest each face different scenarios that could potentially lead to cost creep in the near to medium term. Alaska explained that there were costs associated with its acquisition of Virgin America in its full year 2016 forecast; however, Alaska plans to exclude costs associated with the acquisition and integration from its guidance, on the basis that the timing and amounts of those costs are variable. However, Alaska's costs will rise as it works to integrate Virgin America into is operations. The company has estimated that one-time costs associated with the acquisition of Virgin America range from USD300 million to USD350 million. The average annual run rate synergies are estimated at USD225 million.

See related report: Alaska Air Group-Virgin America: Alaska deleverages to expand US market share

jetBlue is in the process of negotiating the first collective bargaining agreement with pilots since the work group voted to join the Air Line Pilots Association in 2014. Similarly to other pilots, those employed by jetBlue will no doubt seek pay parity with their US peers.

An Apr-2016 study of pay rates by jetBlue's master executive council - comparing rates for a 12-year captain of Airbus A320/A321 and Boeing 737-800/900 narrowbodies - shows that jetBlue's rates are lower than those of American, Alaska, Southwest and Delta. Both Southwest and Delta are engaged in contract talks with their pilot groups, which could result in market rates having a further reset before jetBlue and its pilots forge a ratified collective bargaining agreement.

In addition to engaging in contract talks with its pilots, Southwest is also negotiating a new contract with its flight attendants. The company's pilots have submitted an offer to Southwest management for a 33% compounded pay increase over seven years by Oct-2019. In 2015 Southwest flight attendants rejected a deal that included an 8% ratification bonus and a 3% raise. Southwest and many of its US counterparts face a tough situation: their labour groups are asking for higher pay rates in light of record profitability, yet management needs to ensure that new contracts do not erode their margins.

There is a high likelihood of labour rate and unit cost resets for US airlines soon

Perhaps the norm of falling fuel prices and sliding unit revenues that has occurred in the US market place during the last year has overshadowed the metric of unit cost performance that is still important.

The country's airlines no doubt understand the role that unit costs play in maintaining margins in a declining unit revenue environment.

But many US airlines face cost uncertainty due to the outcomes of their respective labour negotiations. Just as there seems to be a reset in labour rates under way, an accompanying change in unit costs is likely to follow.

Consolidation and the resulting recent profitability are reawakening unhappy employee memories of more than a decade of bankruptcy proceedings, placing the US industry at another important junction. The signs are that potentially substantial cost increases will be built into the longer term outlook for many airlines.

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