Alaska Air Group, Inc. (NYSE:ALK) Q3 2023 Earnings Call Transcript

Alaska Air Group, Inc. (NYSE:ALK) Q3 2023 Earnings Call Transcript October 19, 2023

Alaska Air Group, Inc. misses on earnings expectations. Reported EPS is $1.83 EPS, expectations were $1.88.

Operator: Good morning, ladies and gentlemen and welcome to the Alaska Air Group 2023 Third Quarter Earnings Call. [Operator Instructions] Today’s call is being recorded and will be accessible for future playback at alaskaair.com. After our speakers’ remarks, we will conduct a question-and-answer session for analysts. I would now like to turn the call over to Alaska Air Group’s Vice President of Finance, Planning and Investor Relations, Ryan St. John.

Ryan St. John: Thank you, operator and good morning. Thank you for joining us for our third quarter 2023 earnings call. This morning, we issued our earnings release along with several accompanying slides detailing our results, which are available at investor.alaskaair.com. On today’s call, you will hear updates from Ben, Andrew and Shane. Several others of our management team are also on the line to answer your questions during the Q&A portion of the call. This morning, Air Group reported third quarter GAAP net income of $139 million. Excluding special items and mark-to-market fuel hedge adjustments, Air Group reported adjusted net income of $237 million. As a reminder, our comments today will include forward-looking statements about future performance, which may differ materially from our actual results.

Information on risk factors that could affect our business can be found within our SEC filings. We will also refer to certain non-GAAP financial measures such as adjusted earnings and unit costs, excluding fuel. And as usual, we have provided a reconciliation between the most directly comparable GAAP and non-GAAP measures in today’s earnings release. Over to you, Ben.

Ben Minicucci: Thanks, Ryan and good morning, everyone. Before getting to our results, I’d like to start by acknowledging the human aspect of the work we do. This past quarter, close to home, we saw wildfires bring devastation to the West Maui community. More recently, we have been horrified by the terrorist attacks in Israel and we mourn the innocent lives lost. I want to acknowledge that people are hurting and while we share in the privilege of connecting families and communities, we also share in the pain of seeing those around the world suffer. Now turning to our results. Our third quarter performance continues to demonstrate the underlying strength of our business model and our commitment to drive consistent, measured progress against our goals.

During the quarter, we ran the best operation in the country, delivering a 99.7% completion rate and on-time rate of over 80%. On September 30th, we retired our last Airbus aircraft from service, marking our official return to single fleet. We drove unit costs down nearly 5% year-over-year, a strong performance that stands alone versus our peers in achieving year-over-year unit cost reductions. And our 11.4% adjusted pre-tax margin nearly led the industry despite our lower direct exposure to record international demand as well as significant fuel cost headwinds given our geographic exposure to the West Coast. Now moving to where we are today. Having been in this industry a long time, I know as well as anyone how volatile it can be and we are seeing this now.

Crude oil has risen 12% from last quarter, while L.A. refining margins have increased 70% overall and 60% over Gulf Coast levels disproportionately increasing our economic fuel cost compared to peers, given the majority of our purchasing happens on the West Coast. While we expect this divergence to be temporary, it is nonetheless a near-term headwind. Absent this $50 million cost in Q3, we would have led the industry in adjusted pre-tax margin. Demand remains strong in peak periods, but shoulder periods are becoming more susceptible to lower demand without a full return of corporate travel. Despite these near-term headwinds that will likely make the next quarters more challenging, I continue to believe we have a strong fundamental long-term setup for several reasons.

One, our teams continue to deliver reliability. We now have two solid quarters in a row of industry-leading performance, and I can confidently say we have our operational muscle back. I want to thank all our employees for their hard work and effort. They have done an amazing job prioritizing and delivering a safe and reliable operation for our guests. Our completion rate not only led the industry, but set 20-year company records in all 3 months of the quarter during peak summer flying continuing to surpass our planning expectations. Two, our relative cost advantage comes from decades of discipline and became a highlight in the third quarter. With visibility to another quarter of unit cost improvement year-over-year, we expect full year CASMex to be down 1% to 2%, likely the only carrier to achieve unit cost reductions for the year.

Having retired our last Airbus aircraft in September, we brought our dual fleet chapter to a close and are poised to fully recognize the power of single fleet efficiencies as we move into 2024. Three, we have the most diversified revenue of domestic-focused airlines, generating 45% of our revenue outside the main cabin. Our investments in fleet and premium seating have given us a domestic product that rivals any in the industry, including first in premium class lounges and global partnerships that will continue to serve us well going forward. And four, our growth is rational and disciplined. Having closed out a strong summer operation, our teams are turning their focus to winter preparedness and continuing to deliver strong operational performance for our guests throughout the holidays.

Capacity discipline is the most relevant lever our industry has and will be necessary to support off-peak periods going forward. We are focused on optimizing our flying and moderating growth as a prudent measure to deliver results. For 2024, we are actively discussing where within our long-term 4% to 8% target growth range as most optimal given the higher fuel environment. To close, we produced solid third quarter results. Without our refining margin headwind, we would have had the best results in the industry. Our product set competes with the best and as the international versus domestic demand mix and business travel ultimately normalize over time, we have the right business model to deliver strong results and outperform well into the future.

Now more than ever, we are focused on extracting efficiencies from both sides of the profitability equation with all the elements in place to drive strong relative results within our evolving industry. And with that, I will turn it over to Andrew.

Andrew Harrison: Thanks, Ben and good morning, everyone. Today, my comments will focus on third quarter results, recent trends and our outlook for the rest of the year. Third quarter revenues reached $2.8 billion, up 0.4% year-over-year on 13.7% more capacity, which was approximately 1 point below our revenue guidance midpoint. Unit revenues were down 11.7% versus 2022 and up 12.2% versus 2019. We had three sources of headwinds impacting third quarter revenue performance. First, the strong close-in revenue performance we saw from April through most of August moderated as we moved into September. Close-in demand for leisure looks to have normalized and without further return of business demand, shoulder periods are more challenged than they have been in the past couple of years.

Second, we planned our network for relatively strong demand from summer into September as we experienced last year. However, that did not fully materialize. This led to modest load factor weaknesses in areas of our network where we deployed more capacity than we normally would during the shoulder. Third, the devastating Maui wildfires impacted third quarter revenue and therefore, profit by approximately $20 million. For reference, Hawaii represents nearly 12% of our capacity, with one-third of that deployed to Maui. Following the wildfires in early August, bookings turned negative with high rates of cancellation. This reversed at the end of August as bookings to Maui began recovering. However, September bookings were still down 45% versus last year.

As we move into the fourth quarter, we are seeing continuing recovery in Maui. However, we expect revenues to be negatively impacted by approximately $18 million and anticipate it will be several quarters before demand returns to normalized levels. Having cut a full frequency from Seattle and trimmed capacity from other hubs, we will continue capacity adjustments to match supply with demand while serving the people of Maui during the recovery process. Lastly, although not a part of our baseline, we saw no upside benefit from corporate travel as revenue continues to hold at about 85% of 2019 levels. Having covered our headwinds though, there were several positive results in the quarter as well. With respect to product, our premium cabins continue to materially outperform the main cabin with first and premium class revenues up 10% and 6% year-over-year respectively.

Alaska is the only primarily domestic carrier to have both first class and premium economy across 100% of our mainline and regional fleets. These premium seats represent 25% of our total seats and continue to be an area of opportunity for us in sustaining higher yields and other domestic focus competitors, especially as travel preferences continue to move in a more premium direction. Total premium paid load factor was up 3 points year-over-year, but has increased over 10 points on 12% more seats versus 2019. Today, premium revenue represents 31% of our total revenue, contributing to the 45% of total revenue we generate outside the main cabin. Putting aside premium for a moment, we have also seen success with more guests buying out from saver into our main cabin product.

This buy up has occurred at 22% higher fares versus last year. Loyalty remains a strong driver of revenue performance as well. Bank cash remuneration was up 11% versus the third quarter of 2022, outpacing system revenue that was only up 0.4 point. We continue to make solid progress on our strategy of being able to directly sell our oneworld and other partners on alaskaair.com. We launched 13 partners this year, bringing our total to 18 partners with over 500 destinations worldwide now being sold direct on our website. These efforts will continue as we enable selling all cabins on our partners and continue to upgrade the digital guest experience on our website and within our native app. This is another area where we are clearly differentiated from other domestic focused carriers.

We are the only primarily domestic carrier that offers access to a portfolio of global partners where we offer elite status recognition, accrual and redemption and airport lounge access. This capability, along with our premium cabin offerings, gives me confidence that we will have built the right commercial offerings to meet our guests’ preferences and drive long-term value to Air Group. As we shared on our last call, we have continued to see our guests take advantage of our global partner network with total accrual and redemptions on our long-haul partners, up 26% for the third quarter versus last year. Taking a step back, as illustrated in the supporting slides we published today, when comparing our unit revenue performance versus a 2019 baseline, it’s clear that the differentiation of our products including our premium offering and international connectivity is a very positive story, which has resulted in unit revenues, up 12% on capacity growth of 6%.

This is a testament to the soundness of our business model and the success of changes we have made since 2019. Now turning to fourth quarter guidance. We expect revenue to be up 1% to 4% on capacity that is up 11% to 14% year-over-year. In terms of bookings, holidays are in line with our expectations with load factors up a couple of points and yield up double-digits versus 2019. As I mentioned, non-peak shoulders are weaker than 2022’s historic demand levels in part driven by a return to more normal seasonality and a continued, but we believe temporary demand shift towards international travel. Today, we have approximately 58% of November and 35% of December revenue booked. Given our fourth quarter outlook and current demand backdrop, we are narrowing our full year revenue guide to up 7% to 8%.

Our guide implies that our unit revenue trajectory is improving sequentially in the fourth quarter versus 2022, up 3 points. And we believe the gap to legacy unit revenue performance is also closing sequentially. Our most significant step-up in capacity occurred during the third quarter as we work to restore our pre-pandemic network. However, in the fourth quarter and into the first quarter of 2024, our growth follows more in line with normal seasonal patterns. After growing 6% above 2019 levels in Q3, our growth moderates to less than 3% above 2019 levels from the fourth quarter through February of 2024, which we believe should better support supply and demand dynamics in our market versus the industry. Looking ahead, we remain confident in our commercial plan and cognizant of our environment.

Our team has taken a hard look at our first quarter network amidst high fuel prices as part of our commitment to improving Q1 profitability. We are focused on managing capacity prudently, including capitalizing on leisure destinations, including 15 new routes such as Seattle and Los Angeles to Nassau, which will bring in new revenue while also constraining our total capacity growth to low levels, and reducing business heavy routes and frequencies. For example, we have trimmed our higher frequency Pacific Northwest and California business seats 22% versus January and February of last year. To wrap up, we have a solid commercial plan that is producing results. Our combination of premium products, valuable loyalty program and global offerings through our partnerships in oneworld allows us to provide guests with what they want while producing strong financial results.

And we are looking forward to building on that moving forward. And with that, I’ll pass it over to Shane.

Shane Tackett: Thanks, Andrew and good morning, everyone. As we discussed on previous calls, for the past year, we have prioritized returning Alaska to operational excellence. This is what our guests deserve and it allows us to have more predictability across the company, which we can ultimately leverage to improve efficiency and cost performance. It was encouraging to see during the quarter that as we have delivered the industry’s most reliable operation, our teams have begun to turn the corner on our cost profile as well. And while we acknowledge a more challenged near-term setup with temporary, but elevated West Coast jet fuel refining margin costs and a more typical demand profile in shoulder periods, we remain confident our business has the right configuration to deliver financial performance over the long-term.

For the third quarter, adjusted EPS was $1.83 and we delivered an adjusted pre-tax margin of 11.4%. Unit costs were down 4.9% and economic fuel cost per gallon was $3.26, which was materially impacted by refining margins on the West Coast that averaged $0.30 higher than the rest of the country, which we believe will prove to be an anomaly, but materially impacted our performance relative to others. Absent this refining margin differential or the $20 million of lost profit due to the tragedy in Maui, Alaska would have led the industry in margin despite not enjoying the current surge in international demand or a further rebound of corporate traffic. Our balance sheet and liquidity, long-time pillars of strength for us through many cycles, remain stable and healthy.

We generated approximately $270 million in cash flow from operations during the quarter while total liquidity inclusive of on-hand cash and undrawn lines of credit stood at a healthy $3 billion. Debt payments for the quarter were approximately $93 million and are expected to be $45 million in the fourth quarter. Our debt to cap remains at 48%, unchanged from last quarter, while net debt to EBITDAR finished the quarter at 1.1x, both within our target range. We have also revised our full year CapEx expectation to $1.7 billion for 2023 and fully expect 2024 to be below this amount as we are currently reshaping our near-term delivery stream with Boeing to accommodate a more conservative 2024 capacity plan. Our share repurchase program has, as intended, offset dilution year-to-date, with spend reaching $70 million, while our trailing 12-month return on invested capital ended at 10.7% this quarter.

Moving to costs. The third quarter marked a turning point for us in terms of our performance. CASMex ended down 4.9% year-over-year, coming in below our guided range of down 1% to 2%. This result includes the impact of a larger than initially anticipated market rate adjustment for our pilots, which added approximately $20 million to the third quarter and will annualize at $90 million. Speaking of labor deals during the quarter, we also reached a tentative agreement with our aircraft technicians and we are in the process and looking forward to reaching the deal with our flight attendants. Our unit cost performance was the result of nearly every department of the company coming in on or below their plan, which has been no easy feat to do over the past 3 years as we have re-ramped our operation.

We saw productivity improve 2% year-over-year and we will continue to work toward returning to 2019 levels. Other areas, we saw good performance relative to our plan included maintenance aircraft ownership and selling expenses. ASMs were slightly ahead of guidance on the continued outperformance in our completion rate, providing a small additional benefit to unit costs. And lastly, we have lowered our anticipated performance-based pay accruals given the tougher setup in Q4, which also benefited CASMex fuel this quarter. However, absent both of these last two impacts, unit costs would have still closed below our guide. As Ben mentioned, we crossed a significant milestone to end the third quarter as we retired our last Airbus from service. And in wrapping up our Airbus era, we announced this morning that we reached an agreement to sell the 10 A321s to our partner, American Airlines and expect deliveries to occur over the next two quarters.

Lastly, as I mentioned, fuel became a significant headwind during the third quarter. L.A. refining margins diverged materially from Gulf Coast levels moving from less than $0.08 difference on average for the first half of the year to $0.30 during the third quarter and at times exceeding $0.90. While we have every expectation this divergence is temporary, it has created a material headwind to our near-term profitability. Our economic fuel costs increased from the midpoint of our original guide, adding approximately $110 million of total cost to the quarter with $50 million coming from refining margin disparity or an approximately 2 point margin headwind for the quarter. For the fourth quarter, we expect fuel price per gallon to be between $3.30 and $3.40 per gallon, which is an approximate 4-point impact to margin compared to our expectations back in July.

Fuel, combined with pricing moderation, have led us to revise our full year adjusted pretax margin to 7% to 8%, approximately 3 points lower than the midpoint of our prior guide. We expect CASMex to be down 3% to 5% year-over-year in the fourth quarter, and our full year CASMex to now be down 1% to 2% on capacity, up 12% to 13%. To close, we have run an excellent operation for several quarters. Our pretax margin exceeded peers with greater international tailwinds despite a refining margin disadvantage and sizable impacts from the Maui wildfires. We delivered a strong unit cost result for the quarter and have visibility to another strong result next quarter. We remain focused on and very intentional about setting targets and ensuring we take the right steps to deliver against them.

Our commercial offering with premium cabins and global access through our alliances is configured to compete in a way other domestically focused carriers cannot. Our operational strength has returned and our cost management is outperforming the industry, all of which are fundamental drivers of sustained long-term success. And with that, let’s go to your questions.

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Q&A Session

Operator: [Operator Instructions] And our first question today comes from Duane Pfennigwerth with Evercore ISI.

Duane Pfennigwerth: Hey, thanks. Good morning. So you gave an update, I think, a week or so into September. Can you just talk about what shifted over the latter part of the month? How that played out relative to kind of what you thought what, September 9?

Andrew Harrison: Hi, Duane, it’s Andrew. Yes, I think there was like at the beginning of September, I think we had reiterated our guide. I think two things. We were still getting our hands around Hawaii, which was deeply negative bookings, and we’re trying to get clarity about where that was going to end up. And I think the other part was there was also right around that time with sort of that transition coming off the back end of a peak summer demand and also close in moving into the more traditional business season. And I think those couple of things combined. I think on $2.8 billion, it was probably like $15 million we’re off. So that’s the main reason. But fundamentally, the business was where we thought we were going to be.

Duane Pfennigwerth: Okay. And then just segue to Hawaii. Can you maybe play back some history and talk about the current picture and maybe delineate between Maui and non-Maui bookings, that would be very helpful.

Andrew Harrison: Yes. I think like Maui obviously stands out significantly different, and we’re making some of the capacity adjustments there. We did see during this horrible period of time, some bookings continue to move to other islands. But, as you know, Hawaii books well in advance. So essentially, pretty much the rest of the year Maui, we were sort of reset, but as we go into next year, we don’t see any reason that Maui won’t continue to recover, and we won’t see traditional good solid demand to our Hawaii franchise.

Duane Pfennigwerth: Okay. Sorry to be deliberate there. Hawaii bookings ex Maui, would you characterize that as stable/normal?

Andrew Harrison: They’re a little softer than historical, but we’ve seen that for some time. I think just as – just the capacity into the islands and, of course, some of the pricing presses in Hawaii, the cost of going to Hawaii. But overall, we feel pretty good about it being somewhat stable.

Duane Pfennigwerth: Thank you very much.

Operator: And our next question will come from Savi Syth with Raymond James.

Savi Syth: Hey, good morning. I wonder if you could talk about the revenue trend where you are seeing kind of a better improvement of some of the – your peers that have reported. And you talked about some of the components like how your capacity is developing, but I was curious if you can kind of provide a little bit more color on the contributors of that sequential improvement and how we should think about it then as you go into the first quarter and you make more adjustments as well?

Andrew Harrison: Yes, thanks, Savi, it’s very interesting. I think what’s really positive and some of the sequential improvement is you just look at our capacity in the third quarter and how much higher it was versus ‘19 versus the fourth quarter. And then some of the – as I shared in my prepared remarks, where we had pushed summer capacity out into the fall in some of these Mid-Con markets and some of these other key areas. We brought that capacity back down starting in October, and we’re already seeing the positive effects of doing that.

Savi Syth: Got it. That’s the big driver. And if I might, on the growth plans that you kind of mentioned for next year, it sounds like you’re still kind of evaluating between 4% and 8%. The first half kind of maybe on the lower end of that 4%, it seems like? Or how should we think about maybe early indications? I know you’re probably not ready to give a full guide.

Andrew Harrison: Yes. I mean that’s correct. And we’ve been clear as we go into the first quarter, we’re going to be around 3% or so over ‘19 levels. And again, we’ve looked really hard at our lowest demand period for Alaska at least in the January, February time period, and we feel like we’ve made some pretty good reductions there, and we made that well ahead of the bookings of those flight. So we feel really good about the setup as we go into the first quarter.

Savi Syth: Helpful. Thank you.

Andrew Harrison: Thanks, Savi.

Operator: We will move next to Andrew Didora with BofA Global Research.

Andrew Didora: Hey, good morning, everyone. Andrew, in your prepared remarks, you said your – it seems like you’re booked well ahead for November than another airline that reported earlier today is the 58% book sort of a normal cadence for you, or is it more of how you’re looking at close in trending today and just wanting to book more of that a little bit further out than usual.

Andrew Harrison: I think our comments were a little bit related to when you compare it back to, say, 2019 sort of Thanksgiving sort of falls within the month. So – but if you average it out between Thanksgiving and Christmas sort of in November and December. We’re probably a little higher on the bookings, but not very much. And right now, we’re just making sure that we manage that coming in with good solid yield to close out the year.

Andrew Didora: Okay. Understood. And then also, Andrew, on the last call, I thought you shared some good statistics on the shift you’re seeing to international bookings on your partners over the summer, curious if you’ve begun to see more of a normalization there and maybe share shift back to domestic, or do you continue to see that elevated international demand booking on your partners. Thanks.

Andrew Harrison: Yes. Thanks. I think we’re seeing exactly actually what we saw on the domestic front, whereas last year pushed well into the shoulder season. I think that’s what we’re seeing, at least from our members on the international. So just to remind folks, in the summer, we reported in that we were up sort of 50% of our members year-over-year accruing and redeeming internationally. That number is only 26% for the fourth quarter. So we’re certainly seeing it coming down. And so of course, the question will be, will that get normalized by next year. What we’re seeing right now is it’s on its way to normalization.

Andrew Didora: Great. Thank you.

Ben Minicucci: Thanks, Andrew.

Operator: And we will move next to Helane Becker with TD Cowen.