Alaska Air slows growth outlook and projects revenue uptick as merger costs peak

Alaska Air Group, parent company of Alaska Airlines, posted year-end results that met Wall Street expectations with a $1 billion profit for 2017, including a hefty $274 million benefit from the recent tax legislation.

And on Friday, the company will pay out $118 million in annual performance bonuses to its more than 23,000 employees – about half to its Puget Sound-area employees.

Management said the costs of the merger with Virgin America have peaked while the revenue growth ahead from the enlarged network should be substantial.

However, with labor and fuel costs up sharply and increased competitive pressure from other airlines, Alaska slowed its growth projections.

In a teleconference call with analysts, Chief Executive Brad Tilden cited increased operational costs from higher pilot pay under a contract signed in October as well as a new “power-by-the-hour” engine-maintenance deal.

He said the largest expense item, the cost of merging with Virgin, is under control. The two should have a single reservation and check-in system by late April, smoothing the way for Alaska to realize $65 million in additional revenue from the merger in 2018, and $200 million in 2019.

“This upside is obviously not reflected in current results, but it will be reflected in future results,” said Andrew Harrison, Alaska’s chief commercial officer.

‘Mindset of frugality’

Brandon Pedersen, Alaska’s chief financial officer, said after two years of rising costs, management is looking for increased productivity and cost management, with “a mindset of frugality.”

Pederson said the airline plans to introduce some form of cheaper “basic economy” seating that would segment the main cabin into separate sections to increase revenue.

One likely cost increase ahead in 2018 is a pay hike for flight attendants, who are currently negotiating a contract to cover both Alaska Airlines and Virgin employees.

The pressures from the merger and the cost-saving push have sparked some discontent among employees and made labor relations more fraught than in the past.

Slowing growth

Alaska shares fell more than 8 percent in early trading after the results were announced, but recovered some to close at $62.07, down $2.62 or just over 4 percent.

Shares of all the major airlines had dropped Wednesday, sparked by investor fears that United Airlines’ plan to grow rapidly will undercut prices and profits industrywide.

Even without the Virgin merger, Alaska has grown by 7 to 10 percent annually for the past five years, as measured by available seat miles. Last year it opened 44 new routes in addition to the 38 acquired with Virgin.

And Alaska’s major competitors, including Delta Air Lines in the Seattle market and JetBlue and the other legacy carriers in California and in transcontinental markets, have also increased seat capacity sharply.

Alaska has projected a 7.5 percent increase in capacity for this year.

However, on Thursday, Harrison said about 5 percent of that increase comes from new routes launched last year – and otherwise, capacity growth is stabilizing.

Tilden said projected seat-capacity growth in 2019 and 2020 is now lowered from 6 or 7 percent down to 4 percent each year.

“Fuel prices are up $20 a barrel in just the last six months. (Competitive) capacity is up,” Tilden said. “As we look at the future, we’re going to grow. But . we just don’t think this is an environment that argues for 7 or 8 percent growth.”

This year, Alaska will take delivery of a dozen new mainline jets, increasing its Alaska Airlines fleet to more than 230 aircraft.

It will also introduce 25 Embraer E175 regional jets this year through its partnership with regional carrier SkyWest as well as its own subsidiary Horizon Air. At the same time it expects to retire 13 Bombardier Q400 turboprop planes.

Alaska’s regional fleet will then consist of 95 aircraft, with 58 Embraer jets.

Alaska reported a net profit for the fourth quarter of $367 million, or $2.97 per diluted share.

That compares with 2016’s fourth-quarter profit of $114 million.

The large bump in profits was largely due to a one-time $274 million tax benefit booked in December due to the recent overhaul of corporate taxes.

Excluding one-time items, Alaska reported full-year adjusted profits of $823?million, or $6.64 per diluted share, compared with $911?million or $7.32 per diluted share in 2016.

Comparisons with the previous year are complicated by Alaska’s acquisition of San Francisco-based airline Virgin America in mid-December of 2016.

Bonus time

Alaska, Virgin and Horizon employees in the Puget Sound area will receive about $62 million of the annual performance bonuses.

Company employees also are getting $27 million in California, $12 million in Oregon and $8.1 million in Alaska.

For most employees, the performance bonus on average represents more than 7 percent of their annual pay in 2017.

The money is in addition to the one-time $1,000 bonuses that will be paid to all employees on Monday because of additional tax savings the company expects from the recent tax legislation.

Internally, employees also heard some good news on progress in restoring the flight schedule at Horizon Air, which was reduced last summer due to a pilot shortage.

A management note told Horizon employees Wednesday that, by July 1, the Alaska subsidiary will take back a dozen routes that last year were ceded to regional rival SkyWest using 50-seat Bombardier CRJ-200 aircraft.

Horizon will take over those routes again flying its 76-seat Bombardier Q400 turboprops.

In the memo, obtained by the Seattle Times, Brooke Vatheuer, Horizon’s vice president of finance and planning, called it “a great step for Horizon, and further proof that the investments we’re making in our pilot hiring and training are paying off.”