Alaska Air: Flying Into Troubled Market Forcing Rating Downgrade (NYSE:ALK)

In April 2023, I marked Alaska Air Group (NYSE:ALK) stock a buy based on its 2023 projections. Since then, the stock has lost more than a quarter of its value impacted by different factors affecting the airline industry, but some impacted are more specific to Alaska Airlines. In this report, I will be discussing the most recent results and I will be using a combination of fundamentals and forward projections in our evoX Financial Analytics to determine the price target and adjust my rating for the stock if there is need to do so.

For the third quarter, analysts were expecting revenues of $2.87 billion and core earnings per share of $1.87. The Alaskan carrier missed estimates on both as it reported revenues of $2.84 billion and core earnings of $1.83. Year-over-year, revenues remained stable on a 14% increase in capacity, which seemingly points at lower unit revenues and yields. What affected revenues was a $20 million reduction in revenues while leisure travel did not extend as deep in September as expected and corporate travel remained stagnant at 85% of 2019 levels. The result is that capacity was deployed on routes where the demand was not as strong as seen in the comparable period last year resulting in load factor pressure. Even without the negative Maui impact on revenues, which is expected to provide a negative impact of around $18 million in the coming quarters, revenues would only have increased 1.1% or 0.9% for passenger revenues so the lower revenue generation on higher capacity is evident.

Total costs declined by 5% and that is actually somewhat refreshing giving that many airlines are seeing costs rising. Excluding special items, the costs would be 2% lower. Reported fuel expenses dropped by 21% but also included unrealized positive adjustments of $35 million this year compared to a negative adjustment of $131 million last year. Incorporating this, the operating expenses would be 5% higher.

Unit revenues dropped 12% while yield dropped 10% while CASM-ex dropped by 5% putting on display good adjusted cost control but disappointing revenues due to the deployment of capacity in markets that did not perform as expected and business travel insufficiently carrying Q3 demand.

Alaska Airlines Guidance Update Demonstrates Cost and Demand Pressure

For the fourth quarter, revenues is expected to be up 1 to 4 percent but driven by higher fuel prices, the adjusted profit margin will be slim at 0 to 2 percent. For the full year the company expects capacity to be up 12 to 13 percent which narrows the range from the 11 to 13 percent expected previously. Revenues, however, are guided to be up 7 to 8 percent compared to a previous estimate of 8 to 10 percent putting on display the change in different market dynamics this year which included weaker close-in bookings. Adjusted margins will be 7 to 8 percent adjusted downward from 9 to 12 percent due to higher fuel prices and weaker unit revenues. Earnings per share had previously been guided to the range of $5.50 to $7.50 and are now expected to fall short materially in the $4.25-$4.75 range.

Alaska Airlines is facing several pressures that are specific to the airline. Its Maui operations represent 4% of its capacity and while bookings have recovered somewhat in recent months, they are still down 45% with expected revenue pressure of $18 million with several quarters for demand to normalize. Furthermore, the higher fuel prices in the West are providing a headwind. In Q3, the disparity between the Gulf Coast and West refining margins caused a $50 million higher fuel cost which provides a near term headwind to earnings. Alaska Airlines is also negotiating new labor agreements with cabin crews and mechanics which likely will translate to labor costs rising even further.

Is Alaska Airlines Stock A Buy?

While there definitely are uncertainties in the airline industries and some undesired certainties like higher fuel prices, parsing the balance sheet data and the forward projections still show upside for Alaska Airlines. That upside, however, is skewed more towards mid-decade while the projections for 2024 are expected to include some pressures. As a result, I rate the stock a hold noting that compared to 2024 earnings there is some discount, but that discount is unlikely to be sporting an attractive risk-reward. That is why I am marking the stock a hold.

Conclusion: Alaska Airlines Sees Challenging Times Ahead

Alaska Airlines is one of the companies that looked appealing in the recovery phase for the airline industry. With domestic markets having recovered and unit revenue strength fading while costs are mounting, I am downgrading the stock to Hold as higher refinery margins in the West are putting a pressure on already elevated results while labor costs are likely to increase further and Alaska Airlines misplaced capacity counting on similar booking patterns observed last year.