Alaska Air Group, Inc. — Q1 2016 Form 10-Q
Business context and period: Airline holding company operating Alaska Airlines and Horizon Air. This unaudited report covers the three months ended March 31, 2016; comparisons are with Q1 2015 unless otherwise noted. Dollar amounts are in millions except per-share data and where stated.
Financial and operating results
| Metric | Q1 2016 | Q1 2015 | Change |
|---|---|---|---|
| Operating revenue | $1,347 | $1,269 | +6% |
| Operating income | $290 | $238 | +22% |
| Operating margin | 21.5% | 18.8% | +2.7 percentage points |
| Income before tax | $292 | $240 | +$52 |
| Net income | $184 | $149 | +23% |
| Diluted EPS | $1.46 | $1.12 | +30% |
| Operating cash flow | $525 | $514 | +$11 |
| Property and equipment additions | $119 | $279 | -$160 |
- Fuel expense fell $68 million (29%) to $167 million, mainly reflecting a 35% decline in raw fuel cost per gallon despite 11% higher fuel consumption. Non-fuel expenses rose 12% to $890 million; total operating expenses increased 3% to $1,057 million.
- CASM excluding fuel decreased 1.2% to 8.51 cents. Consolidated capacity (ASMs) grew 12.9%; traffic grew 11.0%, while load factor fell 1.4 points to 82.0%. Passenger revenue per ASM declined 7.7% to 10.84 cents.
- Cash and marketable securities totaled $1.564 billion at March 31, up from $1.328 billion at year-end. Total debt was $647 million, including $116 million current and $531 million long-term, down from $683 million at year-end. Shareholders’ equity was $2.455 billion.
- Operating cash flow less property and equipment additions was $406 million. The company reported $184 million in net income; cash and cash equivalents alone were $78 million.
- Q1 shareholder returns included $127 million of share repurchases and $34 million of dividends; the declared dividend was $0.275 per share.
Material changes and management commentary
- Revenue increased $78 million. Passenger revenue rose 4%; other revenue increased 19%, principally as Mileage Plan revenue grew $27 million (36%) on higher miles sold and improved credit-card partner rates.
- Management attributed higher pretax income primarily to increased revenue and lower fuel expense, partly offset by $94 million of higher non-fuel expenses. Wage and benefit costs rose 10%, and average full-time-equivalent employees increased 8.2%, largely supporting growth. Maintenance, depreciation, food and beverage, and third-party regional carrier costs also increased.
- Alaska Mainline pretax profit was $278 million versus $228 million; Alaska Regional profit was $13 million versus $7 million. Horizon recorded a $2 million pretax loss versus a $6 million profit, reflecting higher costs including bonuses, restructuring, and maintenance work.
- Both airlines reported strong on-time performance: 87.5% for Alaska and 87.9% for Horizon. Management said Alaska ranked first among the six largest U.S. airlines for on-time performance over the 12 months through February 2016.
Outlook, transactions, and risks
- Excluding Virgin America, management forecast full-year 2016 consolidated capacity growth of about 8% and CASM excluding fuel and special items of 8.25–8.30 cents, roughly 0.5% lower year over year. For Q2, it forecast capacity growth of about 11% and CASM excluding fuel of 8.00–8.05 cents, roughly 1% lower year over year. Mainline full-year capacity growth was forecast at about 6.5%.
- Management expected competitive capacity in its markets, particularly Seattle, to increase; schedules then indicated a 14% increase in Q2 and Q3. The company cautioned that unit revenue weakened amid capacity growth, competition, and lower fuel prices.
- On April 1, 2016, after quarter-end, Air Group agreed to acquire Virgin America for $57 per share, approximately $2.6 billion in cash, and expected to assume its debt and lease obligations other than related-party debt. Closing was expected by January 1, 2017, subject to shareholder, regulatory, and other conditions. The company planned to fund the purchase with cash and secured debt. Management reduced expected 2016 shareholder returns to approximately $325 million because of the pending deal.
- On April 11, Horizon ordered 30 E175 aircraft, with options for 33 more; deliveries are expected to begin in 2017. The order was not included in quarter-end aircraft purchase commitments but was reflected in the company’s forward capital expenditure outlook.
- Key risks include regulatory or shareholder failure or delay of the Virgin America transaction, integration challenges, and increased debt and other obligations. Other cited risks include competition, fuel-price volatility, operational disruptions, labor matters, concentrated markets, and dependence on aircraft and parts suppliers. The company also disclosed substantial aircraft purchase, lease, and capacity-purchase commitments.
- Credit facilities totaled $252 million with no borrowings; the company reported compliance with a $500 million minimum unrestricted cash and marketable securities covenant. Management stated it had no immediate plans to draw on the facilities. It also warned that certain credit-card agreements could require reserves if cash and marketable securities fell below $500 million or specified credit-rating conditions were met.
Important facts for investors to verify
- Progress, approvals, financing, assumed obligations, and integration costs for the Virgin America acquisition, including any impact on guidance and shareholder returns.
- Whether capacity growth and competitive pressure continue to weigh on load factor, yield, and passenger unit revenue.
- Fuel prices and hedge outcomes, alongside the pace of non-fuel cost growth and the execution of forecast CASM reductions.
- Funding needs and liquidity relative to aircraft commitments, lease and capacity-purchase obligations, and the planned E175 deliveries.
- Timing and financial-statement effects of the new revenue-recognition standard; the company expected a material increase in deferred revenue related particularly to Mileage Plan miles, but had not yet assessed the full impact.