Alaska Air Group, Inc. (NYSE:ALK) Q1 2023 Earnings Call Transcript April 20, 2023
Operator Good morning, ladies and gentlemen, and welcome to the Alaska Air Group 2023 First 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 first quarter 2023 Earnings Call. This morning, we issued our earnings release, which is available at investor.alaskaair.com. Today, you’ll 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 a first quarter GAAP net loss of $142 million.
Excluding special items and mark-to-market fuel hedge adjustments, Air Group reported an adjusted net loss of $79 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.Benito Minicucci Hello, and good morning, everyone. Before I begin, I want to welcome Ryan St. John as our new Head of Investor Relations.
Ryan is a 15-year veteran of Alaska and also leads our financial and resource planning groups. I’m excited to see Ryan step into this role and know he will do a great job in it. I also must acknowledge Emily Halverson, who Ryan is replacing. Emily stepped into the IR role at the onset of the pandemic, not the easiest time to learn how to do this important and challenging work. Emily has been fantastic as our Head of IR, but this change will allow her to fully focus on leading our accounting and financial reporting functions as our controller.So now turning to our results. Despite our first quarter loss, I am pleased to report that our operational and financial performance trended positively as we progressed throughout the quarter. We are actively driving improvements in our business, and I believe we are well positioned to capitalize in the second and third quarters.
It’s important to note that Alaska, along with the entire industry, historically experienced weaker results in the first quarter, and our loss is primarily a reflection of our current network seasonality.In the past, Alaska has found ways to breakeven or earn a small profit in the first quarter. Therefore, we are setting a target to reduce our first quarter profit seasonality over the next few years. That’s the right goal for us to have in the future, and it will have a meaningful impact on our full year results. The start of this year has presented more challenging weather conditions than we’ve seen historically. Persistent storms, regular snow and elevated icing conditions throughout January and February across all our geographies, including California, led to higher cancellation rates than normal.Additionally, volcanic ash in Alaska and the Pacific Northwest recently disrupted our operations for several days.
Despite these challenges, we still operated with one of the best rate year-to-date. We will continue to prioritize operational performance, and we remain committed to delivering a reliable experience for our people and our guests, especially as we move into peak demand periods. Although we can’t control what Mother Nature throws at us, I have set a goal for our teams to significantly harden our operational resiliency before next winter and to reduce cancels and customer impacts from weather to the greatest extent possible.The total impact of storms in Q1 were in the order of $13 million. But most importantly, this quarter, we delivered on metrics that were squarely within our control. First quarter capacity, revenue and unit costs, excluding fuel, all landed within our originally guided ranges.
I am particularly encouraged to see less close in variability and greater stability when forecasting company performance than we’ve seen in the past 3 years as stability returns, our ability to execute on our cost and commercial initiatives improves. Looking ahead, our outlook and priorities remain unchanged as we continue to execute on our strategic initiatives.Our teams remain focused on returning us to the foundational strengths that have served Air Group well for decades. These strengths, including operational excellence, disciplined cost management, high productivity and low overhead will continue to be the primary drivers of consistent, profitable growth, and we are making good progress on several fronts. Our productivity trends are improving.
Total passengers per FTE is up 6% compared to last year, and we have increased total aircraft utilization by 14%.In fact, our mainline utilization has exceeded 2019 levels. Absentee and attrition rates have declined across all work groups, including pilot attrition rates after the ratification of our new contract back in October. With several labor contracts signed last year, we are looking forward to reaching a deal with our flight attendants and aircraft technicians soon to complete the cycle. Our move to a single mainline fleet is driving better economics. We have improved fuel efficiency by 4% year-over-year this quarter or the equivalent of $25 million and 7 million fuel gallons saved as a direct result of the superior MAX aircraft in our fleet.This is equivalent of taking 15,000 cars off the road each year.
Additionally, our upgauging strategy, which adds 28 more seats per aircraft than the A320s we replaced, allows us to unlock growth efficiencies without adding departures within an already constrained operating environment. As a result, we are now producing 20% more ASMs per aircraft than we did at this time last year.Finally, our balance sheet continues to be a pillar of strength. Our trailing 12-month return on invested capital has continued to improve, reaching double digits for the first time since the pandemic began. Our financial strength has also allowed us to support a long history of shareholder returns, and during the first quarter, we officially restarted our share repurchase program to offset dilution and remain on target to spend at least $100 million this year.As we approach our busy Q2 and Q3, we are well prepared for peak summer flying.
We have taken proactive steps to prepare our airline, including doubling our pilot training throughput compared to the same period last year and providing a 1-day immersive care retreat to 14,000 guest-facing employees. This retreat emphasized our core values of being kind-hearted and doing the right thing as well as focused on self-care, team care and guest care, which are essential to our culture. This has become even more important and necessary in leadership’s view post-pandemic.Our people are integral to our success, and I am proud of the work they do preparing our airline to meet demand while performing at a high level of operational excellence. We have taken deliberate steps to build momentum coming out of this recovery and to fortify our ability to deliver on our targets.
As we look forward, we have line of sight to returning to strong double-digit adjusted pretax margins this quarter. And assuming a stable economy, we remain confident that we will deliver our full year adjusted pretax margin of 9% to 12% and earnings per share of $5.50 to $7.50, which we believe will be at or near the top of the industry.Despite the potential for a recession and softening in some sectors of the economy, travel demand remains strong. And while our industry and business may face continued economic volatility in 2023, it remains to be seen if there will be any negative impact on revenue. At Alaska, we have a proven track record of adapting and navigating challenging environments. As we progress on our road map to profitable growth, we are already seeing the benefits of restoring our historical strength as a single fleet operator and unlocking new commercial initiatives.
This positions us well in any environment to continue to deliver on our financial commitments and drive our long-term success. And with that, I’ll turn it over to Andrew.Andrew Harrison Thanks, Ben, and good morning, everyone. My comments today will focus on our first quarter results and in particular, on March, which I believe is more indicative of what we see going forward. I will also share our thoughts on second quarter trends and guidance.First quarter revenues totaled $2.2 billion, and that’s up 31% versus the first quarter of 2022 with capacity up 14% over the same period. This marked a significant milestone for us as we finally restored capacity to pre-pandemic levels, a 3-year journey. Load factor came in at 80%, exceeding last year’s load by 3 points as we lap the effects of Omicron in early 2022.
Even when comparing our results to 2019, we delivered strong revenue progression throughout the quarter with January unit revenues up 13%; February up 15%; and March up 19%.The strong results in March are a good indication of where we’re headed as we look to the second quarter. Total March revenue came in above our record-breaking March last year on both higher capacity and higher yields while our pretax margin was nearly 2 points better despite higher fuel prices. Throughout my tenure at Air Group, this airline has been solidly profitable 10 months of the year, with January and February always being the most difficult due to our network configuration and predominantly leisure consumer base. Layer and business travel that hasn’t fully recovered plus exceptionally high fuel prices, and it made for a tough quarter.As Ben mentioned, we are committed to driving improvements in these months to accommodate seasonally low demand with an aim to return to breakeven or better in the first quarter in future years.
Moving to business travel. Nearly all of our core hubs are in geographies where business has not returned as quickly as in other major economic centers throughout the country, corporate layoffs and a heavy concentration in the tax sector being major contributors. Yet despite the lagging tech sector, which is roughly 50% to 60% restored to pre-pandemic travel levels, overall, business travel remains around 75% recovered by volume and 85% to 90% by revenue when compared to 2019 levels.I believe the lag in West Coast business travel is upside for us, which we have not factored into our revenue forecast. There may be opportunity ahead as corporate travel budgets increase given some companies begin returning to the office and move into new fiscal periods later this year.
We see continuing strength this year in premium and loyalty performance. First and Premium Class revenues were up 35% and 33% year-over-year, respectively, on higher payload factors and fares. This front cabin preference has persisted, and I expect this trend to continue.Bank cash remuneration also remains strong as we lap the anniversary of our renewed credit card deal with Bank of America. For the quarter, it was up 17% year-over-year. And with the launch of our new card benefits, acquisitions have exceeded our expectations. With the highest quarterly sign-ups in our history, surpassing 100,000 new cards during the quarter. Regarding network and alliances, we are progressing nicely on our plan to unlock selling capabilities for 10 airline partners on our website this year, with the goal of making alaskaair.com a gateway to the world for our guests.
Since our last call, we’ve turned on selling capabilities for Iberia as partner #5, and work is currently underway to launch three more airlines by summer.While we know partner-enabled selling drives positive yield contributions to our network, Direct sales also offer a low-cost distribution channel that not only supports our partners but reinforces to our guests that Alaska Airlines can deliver on their global travel needs, which in turn keeps our guests within our network and loyalty program. I am excited to see this area of our commercial initiatives continue to grow and drive incremental benefit in line with our goals to enable 8% to 10% of our total revenues through Alliance Partners.Turning to second quarter guidance. We have line of sight to delivering strong results above and beyond the record quarter we produced last year during the demand for our industry experienced.
For Q2, we expect total revenue to be up 2.5% to 5.5% year-over-year on capacity that is up 6% to 9%. While we experienced softness in close-in bookings in January and February, which is understandable given the lack of business travel that usually materializes during this period, we exited March seeing improved performance across the booking curve. Near term, we continue to see strength in demand with held yields sitting above both 2019 and 2022 levels as we move into the second quarter.My team is doing a great job optimizing the load and yield equation as capacity and demand remains more stable this year compared to last. I’m very excited to have Kirsten Amrine step into a new VP role overseeing both revenue management and network planning.
Kirsten has spent her 16 years at Air Group in various roles in revenue management. START Her deep knowledge and expertise have been an asset as we constantly learn how to manage our inventory to account for new shifts in booking patterns and make network adjustments going forward.Brett Catlin has done a fantastic job at managing our network for the last 4 years, and he will be taking on direct responsibility for our loyalty and credit card programs, corporate sales and continuing his alliance responsibilities. These leadership changes will ensure that the commercial organization stays laser focused and coordinated on these critical revenue-generating levers. As Ben mentioned, our growth this year is primarily being driven by gauge and stage, a highly efficient form of expansion.
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Having returned to pre-pandemic levels of capacity at a system level, we are focused on building network depth in Portland and working to fully restore our network in many California markets.Looking to the remainder of the year, we are poised to produce strong results as we rebuild our network upgauge efficiently and refine our revenue capabilities within this evolving demand environment. Importantly, we are performing in line with our internal targets and remain confident in delivering on our full year goals. We have proven product initiatives in place, and they will continue to drive value for our business as we move forward. And with that, I’ll pass it over to Shane.Shane Tackett Thanks, Andrew, and good morning, everyone. As Ben mentioned, we experienced improved stability to the business this quarter, which was good to see.
In my experience, the biggest challenge to operational and cost management historically has been volatility. And as that volatility subsides, our ability to drive consistent operational and cost improvements is enhanced. I’m encouraged that we were able to start the year with financial performance, absent fuel price impacts within our original guidance ranges. Alaska has a long history of delivering on our commitments and guidance, and we are focused on doing so again in the second quarter and for the full year.Turning to our balance sheet and liquidity. We remain well positioned with both. Our debt to cap finished the quarter at 48% and our net debt-to-EBITDAR stood below 1 turn at 0.8x, both of these metrics are within our long-term target ranges.
Debt payments were approximately $100 million for the quarter and are expected to be $50 million and $100 million in the second and third quarters, respectively. We generated $222 million in cash flow from operations during the quarter, while total liquidity inclusive of on-hand cash and undrawn lines of credit was a healthy $2.8 billion at quarter end.As our business normalizes and we continue to pay for aircraft deliveries, we will anchor toward the higher end of our target liquidity range of 15% to 25% of revenue or around $2 billion to $2.4 billion, inclusive of lines of credit. Our trailing 12-month return on invested capital surpassed double digits and closed the quarter at 10.6%. The last time we achieved double-digit trailing 12-month ROIC was, not surprisingly, February of 2020.
It’s nice for this metric to, once again, be well above our cost of capital, and our goal is to now remain above 10% and grow from there.We also restarted our share repurchase program this quarter and have spent approximately $23 million year-to-date, a marker on our way to returning to our long-term capital allocation goals. Turning to the performance of the business. We executed to our plan in the quarter, again, absent fuel price. First quarter CASMex was down 1% year-over-year on capacity up 14%, both within our guided ranges. Our teams did an excellent job delivering on their internal targets with the only source of significant variance being the cost of challenging winter weather that Ben mentioned, which was approximately $8 million of cost of the $13 million total impact.Our completion rate exceeded our goal, while daily aircraft utilization increased 14% year-over-year, helping us return to pre-pandemic capacity.
With the retirement of our A320s and Q400s in January, our total aircraft count was down 29 aircraft the ASMs were up 14% versus Q1 2022, demonstrating the impact of both utilization and the benefits of our upgauging strategy. It’s worth acknowledging that our capacity was at the high end of our guide and our CASMex fuel was just below our midpoint. I would like to see us return to our historical pattern of matching capacity outperformance with commensurate cost outperformance, and I’m confident we will ultimately see this. We are wholly focused on continuing to rebuild this muscle over the next several quarters.Fuel was a clear headwind in the first quarter. While crude prices were between $70 and $80 per barrel during the quarter, refining margins continued to be particularly volatile.
Although they have been more stable in the past few weeks at what I would view as reasonable levels. Our first quarter fuel price was $3.41 per gallon versus our original guidance midpoint of $3.25 and versus $2.62 last year. This added more than $30 million of cost versus our guide, which equated to approximately 150 basis points in margin impact.For the second quarter, we estimate our price per gallon will be between $2.95 and $3.15. We hope this is a conservative guide as month-to-date, our all-in per gallon price is close to the $2.95 low end of our guide. At any fuel price within our range, we have line of sight to solid double-digit pretax margins for the quarter with any additional price favorability contributing direct upside opportunity to our results.Turning to capacity and cost guidance.
We expect capacity to be up 6% to 9% versus Q2 2022, and CASMex to be up 1% to 3%. While lower than the 14% year-over-year capacity increase in the first quarter, when comparing to 2019, our Q2 and first half capacity is roughly flat while we expect to step up to low single-digit growth in the back half of the year. From a cost standpoint, the first quarter year-over-year comparison benefited from $35 million of lease return costs rolling off, while this is not the case for the second quarter.Along with lower sequential year-over-year growth, we have a slightly tougher cost comparisons set up this quarter. For the full year, we still expect to reduce unit costs 1% to 3% as we drive productivity improvements, leverage the restoration of our full network and lap labor deals in the back half of the year.
Regarding our fleet transition, September 2023 will be the final month we operate the Airbus fleet. At which point, we will retire the last 10 A321s from what was at one point a 72 aircraft fleet. This cements our future as a single fleet operator by 2024. And as a result of this acceleration, we expect to incur approximately $300 million to $350 million in special fleet transition charges through the end of the year.By fully retiring the Airbus fleet at the end of the third quarter, we expect all of our pilot training and associated transition costs should now be completed by year-end with very little spillover into 2024. We will plan to transition the remaining Airbus pilots in the fourth quarter of this year, which will set us up for a clean 2024 from a pilot training and dual fleet cost headwind standpoint.
We still expect to deliver 8% to 10% capacity growth this year.As we’ve mentioned before, following the setbacks we experienced last year, we derisked our 2023 capacity plan considerably and we’ll remain conservative in our capacity commitments as we protect stability and prioritize reliability in our operation. which essentially means that we may continue to perform at the higher end of our guided capacity range if our completion rate continues to be strong.In closing, our management team has been very intentional in setting targets and ensuring we execute the steps necessary to deliver on them. We know we still have work to do. but we are encouraged by our recent results and are optimistic about the second and third quarters, which are our peak performance period.
We remain at the belief that we have core competitive advantages, the right business model and the right strategic initiatives to continue to drive outperformance versus our peers in whatever economic backdrop we encounter. And with that, let’s go to your questions.
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Question-and-Answer Session Operator [Operator Instructions]
And our first question today comes from Savi Syth with Raymond James.Savi Syth I wonder if you could talk about — a little bit about what you’re seeing in terms of kind of pass into travel changes versus pre-pandemic in terms of booking curve, seasonality, day of week or destination. Just curious on how that’s progressing and how that’s impacting how you’re forecasting things.Andrew Harrison So we’re still working and observing a we build back.
But a couple of things I will share is that number one, I think the booking curve is back sort of to 2019 levels. So we’re sort of seeing leisure book further out again. So that’s the first thing. I think second thing on the big day of week changes, Friday and Sunday are still CASM Kings. They generate the highest unit revenues of the week, but we’ve seen Saturday take a step change up, and that’s been one of the strongest increase in unit revenue days of week. And so flying a bit more on Saturdays. I think Wednesday Tuesday or the weakest and then sort of Thursdays on Mondays. Another big change that’s occurred is sort of the advanced booking window. I think in my career, I’ve never seen 30-day advance purchase barriers that have gone up. And we’re seeing that across our network which sort of leads me to believe that essentially business travelers are actually booking further out than they have historically.
And then the last thing I would mention is Ben as well articulated is we need to do a much better job at matching supply and demand and what’s seems to be a weaker January and February with business traffic essentially down 25% at this time.Savi Syth That’s helpful color. And then if I might, on the fleet transition, the special charge that you talked about, is any of that cash this year? And just if you could talk a little bit more about how that transition went in kind of the first part with the A320s and how that’s informing how you do the A321 transition?Emily Halverson Savi, this is Emily. I will start on the cash, and then I’ll hand it over to Nat to talk more about the fleet transition itself. Some of the cash will hit this year. I expect most of it — most of what Shane mentioned, the 300 to 350 to hit over the next 12 months.
We also have some cash that will be incurred this year related to the accruals that were taken last year. So as we work through the remainder of the A320 transition, it’s all through the P&L already, but the cash is still going to be incurred in 2023.Nathaniel Pieper And Savi, on the A321s, it’s Nat. We’re really excited as you gather from Shane, from Ben, from Andrew, really everybody at Air Group to get this fleet transition done and get to single fleet as fast as we can. The plan is in motion. And now the last hurdle we’ve got to get over is to come up with an A321 exit plan, and we’re getting close. Late-stage discussions with a bunch of parties, lessors, financial firms, other airlines, and our objective is to paper the transaction for the 10 aircraft by the end of the second quarter.
And we’re confident the way we’ve structured it that will come out on an NPV and cash flow positive basis versus parking the aircraft to maturity and just making lease payments until then.Operator Your next question comes from Conor Cunningham with Melius Research.Conor Cunningham So the implied exit rate on cost is obviously awesome, but can you just speak to how you get to the high and low end of the full year guide? The reason why I ask is that the ARC seems — the [indiscernible] improvement seems pretty steep from up to the — I think you’re implying basically like down 6% in the fourth quarter. So I just want to understand the puts and takes and how you get there?Shane Tackett it’s Shane. Yes, I think the biggest driver of the second half performance trend is going to be the lapping of labor deals.
I think we talked about this the last couple of quarters. We’ve got about $75 million, $80 million of structural cost increase due to the 6 labor deals we signed last year, they start to lap in August, but the biggest one, of course, is our pilot deal that really starts to lap in Q4. So we’ll be fully through the comp headwinds by the fourth quarter. That’s the biggest one. I think the other thing just to realize is as we grew the first quarter of this year on an absolute basis over the fourth quarter of last year. We held extra resources to do that. We typically down in capacity Q4 to Q1. We stress the operation a bit and we made sure we had ample additional sort of resource to ensure that we didn’t take a hit on completion rate or operational performance, which we did a really good job on the operations.
So I think as we go forward, we’ll get a little more productive with our resources, and then we’ll start to lap these large labor deals.Conor Cunningham Okay. Helpful. And then on the — I think last quarter, there was like endless discussion between the link of fuel and revenue. Today, obviously, sure a lot lower than where it was in January. So you’re reiterating your unit revenue assumptions, I think, for the full year. So I’m just trying to understand, why wouldn’t we be at the lower end of the range if [Jet fuels] here? I know that you have a lot going on. So maybe you could just talk a little bit about the revenue drivers that you have that could offset some of that.Shane Tackett Conor, I’ll start on the fuel. I think what — I think we’ve always sort of felt like unit revenue is going to be more a function of capacity capacity may be more a function of economic sort of backdrop that economic backdrop probably is what drives fuel.
But I think our sort of full year expectation for fuel was in the 3.15 range or 3.20 range. We haven’t decided that it’s going to be materially below that yet. You can see our Q2 guidance is a little bit below that, but certainly above what we’re paying today. If we sort of felt like there was a lot of confidence that fuel was trending below 2.90 or something, yes, I think then we might have a slightly different perspective on unit revenues. But right now, we think it’s too early to tell. Fuel has been super volatile. Refining margins have moved around a lot in the first quarter. So we just — our sort of baseline expectation as what we originally guided to over the — in the first part of the year, which is fuel in the 3.10 and change in unit revenues roughly flat for the full year.Operator Our next question will come from Brandon Oglenski with Barclays.Brandon Oglenski Andrew, I was wondering if you could come back to your comments about sequential RASM here and looking at it year-over-year as well.
Looks like you’re going to be up sequentially, but maybe down from where you were in 2Q ’22. Can you talk to that dynamic?Andrew Harrison Yes. I mean, I think, well, sequentially from Q1 to Q2, you see an absolute unit revenue increase of about 1.5% on sort of giving our seasonality. And as we’ve sort of shared, I think where we’re at right now is our growth is obviously 9-plus percent as we move forward. And so essentially, our goal is to bring in traffic in line with our capacity growth at higher — at essentially revenue unit revenues that were essentially at the same level we achieved last year. So you’re going to see them start to come down a little bit. We have, obviously, very tough comps, but I think big picture for us, the volumes are coming in as we sit here on Q2.
And we’re maintaining, give or take, a few points, our unit revenue increases that we achieved last year. So that’s what goes into the guide, and that’s how we feel pretty good about the second quarter.Brandon Oglenski Okay. I appreciate that. And then can you give us any detail on business travel trends in your network, especially given Silicon Valley Bank in March?Andrew Harrison Yes. I think on a macro level, and again, I just went back and looked at the ARC data as well as our own data around the weeks of all of that. And essentially, the booking levels, there’s blips here and there, but they’ve sort of really been stuck at this back in our network at least 75% with revenues closer to 85% and 90%. And I think as we look forward, we’re not forecasting it, but we’re hoping to see as we move past some of these little shocks to the system that business travel comes back a little bit better than the 75% it’s been at, but we’re not expecting it.Operator And we’ll hear next from Ravi Shanker with Morgan Stanley.Ravi Shanker The last response, you said in your prepared remarks that West Coast corporate travel is an opportunity for you and I completely agree.
