Allegiant results lower in weakest quarter, unencumbering aircraft but still expanding

Despite the fact the third quarter was its 31st consecutive profitable quarter, the increased capacity poured on during its seasonally weakest quarter, drove down Allegiant’s operating margin from the 16.5% experienced last quarter to 12%. However, its total revenues were up 23% to USD163.6 million resulting in a USD19.5 million operating profit. Its net profit dropped 4.5% to USD13.2 million.

CEO Maury Gallagher cited dramatically increased fuel costs. Fuel, he said, increased 43% to USD18.7 million while non-fuel costs grew 21.2% or USD14.3 million. It’s operating margin in the year to date reached 17%, shy of its goal of 20%.

“When we programmed the third quarter capacity increase of 24% we were looking at stronger growth in the first quarter and thought that momentum would continue,” Gallagher told analysts. “We had reasonable unit growth progress back to 2007 levels and 2008 levels and we thought that would continue. In hindsight, we were too aggressive given the consumer slow down in the summer. Historically, when we have grown production we have seen corresponding increases or decreases in unit revenues. In the first quarter, capacity was up 17% and PRASM grew 4.3%. The third quarter was a graphic demonstration that capacity controls revenues.”

The airline is planning to increase the capacity of its 57 MD80s from 150 to 166 seats in a USD50 million capital programme that calls for a complete refit of the aircraft interiors including the removal of galleys. The programme, which will give the airline 650,000 additional seats, is expected to take nine to 12 months once launched in mid-2011. It is also expected to be able to charge a premium for those seats.

Allegiant is now cutting back capacity in an effort to restore unit revenues. “This is critical as we continue to see increases in our energy costs per passenger,” said Gallagher. “This quarter our fuel costs per passenger increased 23% to USD7.39 in the third quarter compared to third quarter 2009. We are seeing near-term strength in unit revenues and expect October’s PRASM to be up 9-10% on a year-over-year basis. Our USD52.34 per passenger ex-fuel expense came in at the bottom end of the USD52 to USD54 per passenger range we guided to in the second quarter 2010 release. This 4% year-over-year increase is well within our comfort level; particularly given our stage length increased almost 6%. As we have said many times over the years, our cost advantage is a critical asset, one that must be guarded closely. Our cost/ASM ex-fuel for the third quarter 2010 was down 0.6% versus the same quarter last year and is more than 30% lower than the nearest LCC.”

Allegiant Travel Company President Andrew Levy noted the carrier was expanding again to six new cities and, new destinations at nine of its current cities. He added that the reason for moving operations out of Orlando International was simply an error in the assumptions that it could charge a premium for those flights. Consequently, it announced earlier this week that it is consolidating Orlando operations back to Sanford.

“We always anticipated costs higher at Orlando International but it was even higher than expected when you look at fuel burn consumption on air traffic routings,” he told analysts. “When we couldn’t get the premium, essentially we were not getting more revenue for a higher expense and that is not a winning combination for us. Moving back to Sanford will be beneficial on the cost site and then there’s the simplicity of one airport that will drive costs lower and make the operation better.”

CFO Scott Sheldon reported the company entered a new credit card processing agreement with Chase Payment Tech, affording reduced processing costs based on financial triggers and performance thresholds. “This will allow us to manage our unrestricted cash and short-term investment balance more aggressively while limiting hold-back requirements,” he said.

Levy explained how the company was adjusting capacity. "We have adjusted our forward capacity plans taking into account the futures curve expectations for fuel prices and assuming no improvement in the demand environment,” he said. “The result is a deceleration of our growth rate starting with this current fourth quarter during which we expect scheduled service capacity growth to increase between 13-15%, down from the 24% growth rate we experienced in the third quarter and down from the 17 to 19% we previously forecast for fourth quarter 2010. Capacity on routes where we have had a presence for at least one year will increase by approximately 3%, so the majority of our growth will come from service on new routes which include a combination of new small cities and connecting existing small cities with new service to an existing Allegiant destination.”

Allegiant will grow capacity modestly – 4-7% – in the first quarter of 2011 but, said Levy, the change in current-market capacity will be down almost 8% in the quarter compared  1Q2010. “We still have time to adjust capacity in the first quarter if warranted, but we are comfortable with our current plan and do not expect any material changes,” he explained. “Since the vast majority of our routes have no direct competition, adjustments to our capacity tend to have a direct effect on unit revenue. We are seeing this in October and expect this effect to carry through the quarter. We are very encouraged by our forward bookings through the end of the year and are pleased with the performance of routes we recently added to the network.”

Levy also reported third-party revenue was up 32% in the third quarter from 3Q2009 to USD6.7 million which he attributed to both higher volume and yield. “On a per-passenger basis, third-party ancillary revenue was up more than 7% year over year and revenue from this business represented 35% of our pre-tax income,” he said. “Las Vegas continues to be strong, but we are also seeing significant improvements in hotel and transportation sales in other markets.”

Finally, he explained two revenue initiatives. The first is offering a discount on the higher-margin vacation packages bundled with hotel. The other is a low-price guarantee which gives a passenger free round-trip airfare if they can find a lower prices air-hotel package. “This will continue to drive more volume and profit,” he said.

The company is working on unencumbering 12 MD80s. It purchased two aircraft that were operating on capital leases during the quarter and retired the debt on eight aircraft. By the end of the year, it is targeting 34 of 51 in-service aircraft for such action.

Fixed fee and other revenues are expected to take a hit in the fourth quarter between 20 and 24% from the 4Q-2009. Its operating expense per passenger ex fuel will be between USD56 million-58 million, down from 4Q2009

It ended the quarter with USD 125.7 million unrestricted cash and short-term investments, down from the USD 178 million with which it finished the third quarter 2009.

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