Alaska Air Group, Inc. — Q3 2019 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2019; comparisons are to the corresponding 2018 periods. Figures are in millions of dollars, except per-share and operating data.
Business context and performance
Alaska Air Group operates Alaska Airlines and Horizon Air, with regional flying also provided by third-party carriers. Management said integration following the Virgin America acquisition was largely behind the company, with focus shifting to revenue growth, operating returns, fleet deployment and customer experience.
Key financial metrics
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Operating revenue | $2,389 | $2,212 | $6,553 | $6,200 |
| Operating income | $422 | $297 | $811 | $597 |
| Net income | $322 | $217 | $588 | $414 |
| Diluted EPS | $2.60 | $1.75 | $4.74 | $3.34 |
| Operating margin | 17.7% | 13.4% | 12.4% | 9.6% |
Q3 adjusted net income, a non-GAAP measure excluding merger-related costs and mark-to-market fuel-hedge adjustments, was $326 million, or $2.63 per diluted share, versus $237 million, or $1.91, a year earlier. Nine-month adjusted net income was $617 million, or $4.97 per diluted share, versus $461 million, or $3.72.
- Revenue and traffic: Q3 revenue rose 8%; passenger revenue increased 8%, driven by 3.6% higher yield and 3.4% more traffic. Load factor was 85.8%, up 0.9 percentage points. Nine-month revenue rose 6%.
- Costs and margins: Q3 operating expenses rose 3%, as fuel expense fell 5% but non-fuel expenses excluding special items increased 7%. Adjusted CASM excluding fuel and special items rose 3% to 8.43 cents. Nine-month adjusted CASM rose 3% to 8.59 cents.
- Cash flow: Nine-month operating cash flow was $1,381 million, versus $986 million. Investing used $708 million, including $527 million of capital expenditures; financing used $538 million. Cash, cash equivalents and restricted cash ended at $249 million, versus $184 million at 2018 year-end.
- Liquidity and debt: Cash and marketable securities totaled $1,619 million, up from $1,236 million at year-end 2018. Debt was $1,709 million, including $265 million current; long-term debt excluding current maturities was $1,444 million. The company reported $516 million of available credit facilities and compliance with their $500 million minimum unrestricted cash and securities covenant. Net adjusted debt to trailing-twelve-month EBITDAR was 1.0x.
- Leases: Adoption of the new lease accounting standard in January 2019 added $1,647 million of operating lease assets and $1,644 million of lease liabilities at September 30. This affects reported balance-sheet leverage and comparisons with prior periods.
Material changes and notable items
- Q3 pretax income increased to $416 million from $284 million. Higher revenue and $27 million lower fuel expense were partly offset by $79 million higher non-fuel operating expenses.
- Q3 wage and benefit costs increased 11%, including approximately $24 million of one-time costs from ratified AMFA and IAM labor agreements. Management expected the agreements to add approximately $50 million annually thereafter.
- The IRS clarified bonus-depreciation rules, reducing Q3 income tax expense by $10 million on a one-time basis.
- The company paid $129 million in dividends and repurchased $53 million of shares during the first nine months. Q3 repurchases were 465,354 shares for $28 million.
- During the first nine months, the company paid $752 million of debt, including $532 million in prepayments, and raised $356 million of secured debt backed by 12 aircraft.
Outlook, risks and contingencies
- Management’s long-term goal is pretax margins of 13%–15% over the business cycle. It expected revenue initiatives and merger synergies to contribute $330 million of revenue in 2019, with full merger-synergy run rate expected by 2021.
- Planned combined network capacity growth was approximately 2.1% in 2019 and 3%–4% in 2020. Management expected economic fuel cost per gallon to be about 8% lower in Q4 2019 than Q4 2018.
- Management forecast 2019 capital expenditures of $700 million and 2020 expenditures of $775 million. It also expected higher full-year wages and benefits, maintenance, aircraft rent, depreciation and third-party regional carrier expense than in 2018, while contracted services expense was expected to decline.
- The FAA grounding of the Boeing 737 MAX delayed aircraft deliveries. The company had commitments for 32 MAX 9 aircraft, with delivery timing updated for the grounding; it also had cancelable A320neo commitments and aircraft purchase options.
- A California wage-and-hour class action involving approximately 1,800 former Virgin America flight attendants resulted in a February 2019 judgment of approximately $78 million. The company is appealing and recorded no loss accrual, citing its view of the legal merits. An adverse outcome could create a material liability.
- Other disclosed risks include fuel-price volatility, competition, labor relations, operational disruptions, economic conditions, market concentration, aircraft incidents, technology and regulatory changes. The filing reported no material change to previously disclosed risk factors.
Investor verification priorities
- Track whether revenue growth and higher yields can continue while non-fuel unit costs rise.
- Verify MAX grounding developments, delivery schedules, fleet plans and related capital needs.
- Monitor execution and ongoing costs of the labor agreements, and the expected timing of merger synergies.
- Follow the appeal and potential exposure in the $78 million flight-attendant judgment; no accrual was recorded.
- Assess liquidity and leverage using operating lease liabilities as well as debt, and review compliance with credit-facility covenants.
- Compare management’s capacity, fuel, expense and capital expenditure outlook with subsequent results; the filing notes interim results are affected by seasonality and fuel-price volatility.