Were it not for fuel hedging losses, Alaska Airlines would have posted record net income during the third quarter. But unlike Southwest, which was pushed into the red, Alaska retained profitability by posting USD77.5 million in net income, down from the USD122.4 million posted in 3Q2010. Excluding special items, the company would have bested 3Q2010 income of USD118.1 million by posting net income of USD131.1 million.
Analysts expected USD118.5 million in profits for the quarter. The company noted a 12% increase in operating revenues of USD130 million as fuel prices offset traffic gains. Higher advanced bookings and load factor boosted Alaska’s confidence that demand is remaining stable.
The company echoed peers in reporting strong demand going forward. It also noted its expected 3-5% increase in capacity in 2012 as it back fills competitive capacity declines on industry expectations that traffic falls off in the first quarter.
Consolidated capacity is expected to grow 3% in the fourth quarter with booked load factors improving during the period. At this point, they are up 1 point for October, 1.5 points for November and 0.5 points for December.
CFO Brandon Pederson pointed to the company’s 17.7% pre-tax margin, saying it was unchanged year-on-year and was likely the best in the industry once again. The trailing 12 months return on invested capital (ROIC) is at 12% and is expected to exceed Alaska’s 10% ROIC goal for the second consecutive year.
Mr Pederson presented the guidance for the airline saying it was on track to achieve its USD 7.3-7.4 cent cost per available seat mile (CASM) ex fuel goal. In the third quarter, it had guided to a USD 7.27 cent mainline CASM ex fuel but bested that as costs were better than expected. For the full year it is expecting USD 7.6 cents CASM ex fuel, on target with the guidance presented in Jan-2011.
Mainline unit costs will be up 1-2% on a 4% increase in capacity, he said, adding the goal is to achieve tight control on unit costs on overhead coupled with productivity improvements. Per passenger employee productivity improved in the third quarter for a nine-quarter consecutive streak.
Unit costs are expected to drop again in 2012 but not at the dramatic rates taken in 2011, according to Mr Pederson.
Regional operations doing well
For Horizon, the adjusted pre-tax profit of USD6.4 million resulted in a 6.9% per-tax margin on USD93 million of revenue, nearly all of which was the capacity purchase revenue from Alaska. The regional is on track to match mainline in achieving a 10% ROIC, he said.
President Brad Tilden added that the company’s regional operations – Horizon, SkyWest and Pen Air – experienced a 4.5% drop in capacity that alternatively drove load factor up 2.4 points and yield up 9.5%. Passenger revenue per available seat mile (PRASM) was up nearly 13%, meaning it is clear the structural changes made to Horizon and its feeder network are resulting in better results.
Its internal accounting shows Horizon having USD800 million in invested capital, which is about 24% of Alaska Air Group's total of USD3.3 billion. Mr Pederson said Horizon’s ROIC, on a trailing 12-months basis is about 4% but year-to-date was 5.9%, on its way to achieving the 10% ROIC over the next couple of years.
Alaska does not count incremental revenues for those passenger transferring to mainline from Horizon because it wants an apple-to-apples comparison of a stand-alone Horizon against its capacity-purchase peers. That means simply subtracting Horizon’s costs from its capacity-purchase revenue from Alaska.
“In that respect, our regional business is doing quite well,” said Mr Tildon, as Mr Ayer added that Horizon has made great strides on reducing CASM. “Once that happens, Horizon will be a significant contributor to Air Group,” said Mr Ayer.
Rising revenues highlight 3Q2011
Mr Tilden briefed analysts that mainline passenger revenue rose USD108 million, or 14% on a 6% increase in capacity and a 7.4% increase in passenger unit revenues, resulting from both yield and load-factor improvement.
Mainline load factor achieved record highs, rising two points to 87%, with September experiencing the largest increase, up 2.5 points which contributed to an 8.4% increase in PRASM. Fourth quarter mainline capacity is expected to grow 4%, boosted by its Nov-2011 launch of a San Diego-Hawaii route that is already experiencing strong bookings. Mr. Tilden reported that Hawaii now accounted for 20% the network.
It expects consolidated capacity growth of 3% in the fourth quarter. Air Group capacity will jump 5% in 2012 as mainline grows 6%.
The company is also introducing a new technique to its revenue management portfolio, splitting December into two parts and dropping capacity in the first half and increasing again in the second half of the month to reflect the differences in loads between the two periods. Mr Tilden indicated that operations have achieved enough stability that it can handle the swings in the schedule, giving the airline increased flexibility to right size the schedule to demand.
Vice president, planning and revenue management, Andrew Harrison, explained that the back filling of capacity as competitors drop capacity, such as the loss of Southwest capacity at Kansas City, comes on the confidence of its experience at both St Louis and Austin, indicating they are similar. Alaska knows how it does in those markets and that Kansas City is about 95% of those markets. There are also no overnight costs for crews.
Chair Bill Ayer added the carrier's confidence also comes from its increased focus on building Seattle over the past few years, which has won it increasing market share, compounded by the feed from Horizon. He indicated one of the more significant changes has come about from ridding itself of markets that do not make money.
“In the old days, we used to hang on to those losers and used to call them strategic,” he told analysts. “We don’t do that anymore and are much faster at reallocating assets to better markets...We don’t see any signs of weakening demand but we have made a lot of network changes to sync our capacity with demand which has resulted in record load factor and PRASM.”
Reducing frequency on weak days
Mr Harrison also noted the company is taking the opportunity to reduce the schedule on weak days such as Tuesday, Wednesday and Saturdays, based on actual demand to increase load factor. This is similar to its December strategy.
“We normally [see] a drop in the first half of December,” said Mr Ayer. “This year we are doing something about it on capacity.”
When asked why the company did not change its hedging strategy given the increasing correlation between fuel costs and the economy, Mr Tilden explained that it views hedging as insuring stakeholders against massive run-up.
“It has saved us USD400 million since 2001,” he told analysts. “Its our way of protecting the balance sheet and this year it has already saved us 30 million. If we see a long-term trend developing of reduced volatility and a better correspondence to the economy, we will think about changing but, to date, we have seen no compelling reason to steer off what we think is a successful strategy. The cumulative savings between 2001 through mid-2008 was USD500 million and between July-2008 it was about USD410 million yielding a net cost of between USD80-90 million.”
Alaska also reported that it, along with the rest of the industry, has become more successful in moving consumers to the airline's own web site, reflecting lower bookings through online travel agencies.
Also, as with the rest of the industry so far, the company reported double-digit jumps in revenues at 12% to USD1.2 billion with record load factor at 86.5% and higher yields besting third quarter months in 2010. Consolidated revenues grew 13.1% on a 7.3% increase in traffic and a 5.4% jump in yield.
Progress was so great, the company said, the rising financial metrics more than offset the 41% increase in economic fuel costs. It also kept non-fuel unit costs in check as they declined by 2.6%, continuing its streak as an industry-leading airline company. It took a USD84.3 million mark-to-market fuel hedge loss as well as incurring USD2 million in fleet transition charges.
Mainline revenues rose 13.9% to USD887.4 million while regional revenues rose 7.7% to USD213.4 million from both Horizon and SkyWest capacity purchase operations. Other revenue jumped 10% to USD67.4 million.
Regional load factor rose 2.4 points to 82.3% as it brought in a 12.7% rise in passenger revenue per available seat mile to 26.28, which has got to be the best in the industry. Horizon ASMs dropped 20.5% on the restructuring of the regional subsidiary to 664 million while CASM ex fuel dropped from USD 14.67 cents in the third quarter of 2010 to USD 12.48 cents.
Consolidated ASMs rose 4.8% to 7.7 billion as load factor rose 1.9 points to 86.5%. PRASM jumped 7.5% to USD 14.21 cents and RASM increased 7.1% to USD 15.64.
Total operating expenses climbed 23.9% to USD1 billion on a 90.2% increase in fuel leaving operating income down 34% to USD143.2 million. Passenger numbers rose 6.1% to 4.8 million as available seat miles jumped at 6% to 6.9 billion. Yield was up 5.3% to USD 14.70 cents with passenger revenue per ASM increased 7.4% to USD 12.79. Operating revenue per ASM increased 6.8% to USD 14.15 cents.
Cost per ASM ex fuel dropped 3.3% to USD7.27 as economic fuel cost per gallon increased 36.3% to USD3.23 per gallon. Consolidated CASM ex fuel and fleet transition costs dropped 2.6% to USD 8.17 cents.
Alaska finished the quarter with unrestricted cash and marketable securities of USD1.3 billion and an adjusted debt-to-total capitalising ratio of 61%, the lowest in history. Its 12-month return on invested capital was a stunning 12%, putting it on target for 10% of the business cycle. It also achieved labour peace with mechanics achieving a five-year contract with Aircraft Mechanics Fraternal Association (AMFA).