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Mark Yu
Mark Yu
Articles (375)  | Author's Website |

A Look at Alaska Air

Airline exhibits exemplary quality

April 21, 2017 | About:

Recent airplane troubles brought some attention to the industry.

Nonetheless, it’s better to focus on companies who lead their corresponding industries. Alaska Air (NYSE:ALK), meanwhile, has earned the top spot in 2016 in the Airline Quality Rating having exhibited exemplary in terms of performance and quality among the largest airlines in the U.S.

The $10.8 billion airline company has stayed in the top five ranking over the past three years prior to shooting up to the top spot.

Earnings performance

The Washington-based airline delivered its fourth quarter and fiscal 2016 results in February. For 2016, Alaska Air delivered 5.9% sales growth to $5.93 billion and 4% profit drop to $814 million – 13.7% profit margin compared to 15% in fiscal 2015.

As observed, the airline experienced 6.6% increased in its overall operating expenses having included a 236.6% jump in special items charges to $117 million, which caused the profit decline for the recent period.

According to filings, Alaska Air recorded the $117 million charge in relation to its merger-related costs associated with the Virgin America acquisition. These costs consisted primarily of legal expenses, investment banking fees and severance costs. Further, the airline expects to continue to incur merger-related costs in 2017.

"2016 was an incredible year for Alaska in almost every way, and we are even more excited as we look forward to 2017 and beyond.

"Our people are rallying around a common purpose of creating an airline people love, and we are well on our way, with benefits like reciprocal mileage and easy booking of Virgin America flights on alaskaair.com already available. I want to thank our people for providing our guests great service, and for staying focused on running a safe and reliable operation." – Alaska Air CEO Brad Tilden

Alaska Air shares rose 3.3% by market close after earnings report in February and is expected to report its first quarter fiscal 2017 results on April 26.

Total returns

Alaska Air has underperformed the broader Standard & Poor's 500 index so far this year with 1.4% total losses compared to the index’s 5.07%, according to Morningstar data. The airline significantly outperformed the index in the past half decade with 39.1% total gains vs. 13.6%.

Valuations

Alaska Air is currently more expensive than its peers. According to GuruFocus data, the airline company had a trailing price-earnings (P/E) multiple of 13.3 times vs. industry median of 10 times, a price-book (P/B) value of 3.7 times vs. industry median of 1.6 times and a price-sales (P/S) ratio of 1.8 times vs. industry median of 0.67 times.

Alaska Air also had a 1.3% trailing dividend yield and a 17% payout ratio.

On average fiscal 2017 sales and earnings-per-share expectations, Alaska Air had 1.3x and 11x multiples.

Alaska Air Group

Alaska Air Group is the holding company of Alaska, Virgin America, Horizon and other business units.

Alaska Airlines is an Alaska corporation that traces its route as an organization to 1932 and was incorporated in 1937. Virgin America, meanwhile, is a California corporation that was incorporated in 2004 while Horizon is a Washington corporation that began service and was incorporated in 1981. It was acquired by Air Group in 1986.

In 2016, Alaska Air carried an all-time high 34 million guests compared to 32 million passengers in 2015. The prestige airline closed its acquisition of Virgin America in December 2016.

Virgin America acquisition

(Press release)

Alaska Air Group became the fifth-largest U.S. airline after it closed its Virgin America acquisition.

According to filings, Alaska Air Group has 34% of its total capacity in West Coast, 29% in Transcon/midcon, 17% in Hawaii and Costa Rica, 14% in Alaska, 5% in Mexico and 1% in Canada.

Alaska Air Group indentified three reportable operating segments: Mainline, Regional and Horizon.

(10-K)

Mainline

Mainline segment includes Alaska's and Virgin America’s scheduled air transportation for passengers and cargo throughout the U.S. and in parts of Canada, Mexico, Costa Rica and Cuba.

In 2016, Mainline sales grew 5.9% to $4.94 billion or 77.7% (largest) of total company sales having excluded consolidating and special items adjustments. The segment also reported a 27.1% (most profitable) margin in income before tax margin compared to 25.9% in 2015.

Alaska Air Group identified that strong growth was realized from its Mainline division secondary to its capacity increase but was offset by lower passenger revenue per available seat miles (PRASM*). PRASM decreased by 5.4% in 2016.

Further, the Virgin America acquisition that closed in December contributed 2% of the 9.9% capacity increase in 2016.

*PRASM passenger revenue per ASM; commonly called “passenger unit revenue.” ASMs available seat miles, or “capacity”; represents total seats available across the fleet multiplied by the number of miles flown.

(10-K)

Regional

The Regional division includes Horizon's and other third-party carriers’ scheduled air transportation for passengers across a shorter distance network within the U.S. under capacity purchase agreements (CPA). Further, this segment includes the actual revenues and expenses associated with regional flying as well as an allocation of corporate overhead incurred by Air Group on behalf of the regional operations, according to company filings.

In 2016, sales in the Regional division grew 6% to $987 million or 15.5% of total company sales excluding adjustments and delivered an income before tax margin of 9.4%, lower than 2015’s 11.3%.

According to filings, Alaska’s Regional division also experienced a capacity increase but was partially offset by an 8.7% decrease in PRASM compared to 2015. Further, the Regional’s decline in profitability was associated to the increase in nonfuel operating expenses current year to support additional departures.

(10-K)

Horizon

Horizon segment includes the capacity sold to Alaska under CPA. Expenses include those typically borne by regional airlines such as crew costs, ownership costs and maintenance costs.

In 2016, sales in Horizon grew 3.9% to $428 million or 6.7% of total sales excluding adjustments and income before tax margin of 3.3% compared to 6.8% in 2015.

The marked decline (~52%) in Horizon’s profitability was mostly secondary to the following: higher medical costs due to an increased number of large medical claims, increased volume of engine overhaul and heavy airframe work, employee signing bonuses and overhead restructuring costs.

Total revenue and net income

(10-K filings)

In the past three years, Alaska Air grew (on average) its sales by 4.8%, profits by 18.4%, and had an profit margin average of 13.4%.

Cash, debt and book value

As of December, Alaska Airlines had $1.58 billion in total cash and marketable securities and $2.96 billion in debt with a debt-equity ratio of 1x compared to 0.28x in 2015.

Of the company’s $9.96 billion assets 20.8% were labeled as goodwill and intangibles having had a book value of $2.93 billion compared to $2.4 billion in 2015.

Cash flow

(10-K)

In 2016, Alaska Air cash flow from operations declined by 12.5% to $1.4 billion. In addition to moderately lower profits, the company had lower cash inflow from air traffic liability and other.

(10-K)

Capital expenditures were $678 million leaving Alaska Air with $708 million in free cash flow compared to $753 million in 2015. The company allocated 46% or $329 million in shareholder payouts including dividends and share repurchases.

In addition, Alaska Air received $2 million from sales and maturities of its marketable securities investments. The airline also allocated $1.95 billion in relation to its $2.6 billion Virgin America acquisition.

(10-K)

Alaska Air also took in $1.82 billion in debt proceeds net payments and other financing activities in 2016.

Conclusion

Alaska Air impressively grew its most profitable segment the Mainline business – comprising its newly acquired Virgin America and Alaska Airlines – in 2016.

In addition, the company expects to further grow its Mainline business this year despite expected continuation of competitive pressures.

Alaska Air’s lower margins and lower sales generating segment, which generated 22% of total Alaska Air Group sales excluding adjustments, also grew their corresponding businesses albeit delivered lower overall profitability brought by identified expenses mentioned above.

The company slightly exhibited a less appealing balance sheet – referring to goodwill and debt figures – in 2016 brought by its acquisition. This includes the increased debt intake Alaska Air took in the same year.

(Alaska Air Group Share Price and Price-Sales Ratio, GuruFocus)

Thirteen analysts have an average price target of $110.54 per share or 25% upside from $88.4 per share (the share price at the time of writing). This would indicate a 14 times earnings multiple – in range of the company’s three-year average of 13.6 times.

Applying a 4% growth rate to its recent fiscal year sales and asking a 20% margin prior to applying the three-year average P/S multiple meanwhile would indicate a value of $8.88 billion or $72 per share.

In summary, Alaska Air is a hold with a target price of $100 per share.

Disclosure: I do not have shares in any of the companies mentioned.

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About the author:

Mark Yu
A doctor in physical therapy (DPT) with a passion for finance. Not a registered financial analyst. Value seeker. Long only. Global investing. Long-term investing.

Attempts to dissect company filings per day. Dislikes goodwill and intangible assets.

For quicker reading--jump ahead to an article's conclusion.

One company (review) a day keeps the speculation (hopefully) away.

Would typically invest $500 to $3000 of own money per buy recommendation.

"The only source of knowledge is experience"

"I have no special talent. I am only passionately curious." Albert Einstein

"To strive, to seek, to find, and not to yield." Alfred, Lord Tennyson

"We find one a year, that's terrific. You do not need a hundred or a thousand great investment ideas to do well. You need a couple. And, the discipline is the most important thing." Warren Buffett

Visit Mark Yu's Website


Rating: 5.0/5 (2 votes)

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Comments

Roger Stera
Roger Stera premium member - 5 months ago

Thanks for the article. I owned ALK for a couple of years, together with Delta and South-West airlines. Alaska Air is a beautiful company if you're still interested in investing in airlines.

(disclaimer: currently not holding ALK, DELTA, LUV no intention to do so within 72 hours)

Mark Yu
Mark Yu - 5 months ago    Report SPAM

Roger Stera,

I appreciate your feedback. I should probably also take a look at those airlines you have mentioned. Meanwhile, I just rode an ALK flight that flew from D.C. to TX, vice versa, pretty okay I must say but no free biscuits were provided compared to when I flew with Delta few months ago :D

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GuruFocus has detected 2 Warning Signs with Alaska Air Group Inc $ALK.
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