Alaska Air Group, Inc. (ALK) Earnings Call Transcript & Summary

All right. Good morning, everybody. I'm Savi Syth, the Raymond James global airline analyst. And up next we have Alaska, which, in my opinion, Alaska is an example of an airline that has done a great job of balancing sustainably serving its customers, employees and investors, which is a challenging thing to do in any industry. And I think once again demonstrated here during the pandemic. So I'm happy to have with us here today, Alaska's CFO, Shane Tackett. So Good morning, Shane. Thanks for being here.

Good morning, Savi. Thanks for having us.

I know it's a very early morning for you here in Pacific Time. So thanks for that.

No problem.

Maybe to begin with Shane, for those investors that are not as familiar with Alaska, I wonder if you could talk about just given an overview of your business model in terms of what your product is, your target customer, your geographical exposure?

Sure, yes, absolutely. We are predominantly on the West Coast, 90 years old, almost for coming up in our 90th birthday. We fly East, West, off the West Coast, all throughout the country with hubs in Seattle, Portland and large operations in San Francisco, L.A., San Diego, San Jose. We fly into a number of leisure destinations. Hawaii is a large part of our portfolio, down to South America, Belize is our newest destination that we started during the pandemic. And I think we -- in terms of a product, we've thought a lot about the business model during COVID, and I think we are as committed as ever to the business model that we went into COVID with, which was low cost, and we've focused on that for the last 20 years. So we're one of the better cost operators in the industry. We've been very disciplined about maintaining our cost structure, but a product that competes very well with other legacy sort of premium-type products domestically. We have the largest first-class pitch in the industry, the largest premium economy pitch in the industry. And so we do very well with sort of premium leisure travelers as well. And the last component, I would mention is our loyalty program. I think we have the most value in our loyalty program. I think folks who watch the industry and judge those things consistently, say we're the most generous in terms of being able to earn free flights and status. And so low cost, really good competitive fares, great product domestically, and I think a brand of service that is unique in the industry. And if you haven't flown us, you should try it. I think our flight attendants and crews on the ground are phenomenal and try to treat people as if they were your guests at your house, and it's just -- it tends to be a nice, calm, not sort of hectic experience, which is different in the airline industry than sometimes what you get other places.

And so I think some of the things you talked about touch on this. So what really differentiates you? What do you view as your kind of competitive moats?

Yes, yes. The cost thing is #1. And I think we recognized that going into COVID. We've long been very committed to managing our costs down. We started this journey 15 or 20 years ago. We had costs that were similar to the legacy network airlines and our costs are now on par or better than the LCCs. And that gives you staying power under any sort of industry condition, any economic condition. And it's the reason that we've sort of thrived over the last 10 years and we're able to sort of wait out the worst part of the pandemic and come out of it as strong or stronger from a balance sheet perspective and cash perspective as we went into it with. And the second piece is our balance sheet. We've been very committed to what we call a fortress balance sheet mentality over the last 10 or 20 years, which for us is really leverage below 50%, really at 25% to 50% debt-to-cap range. Got ahead of that, obviously, during COVID into the 60s to high 60s, but we're back below 50% as we sit here today. So when you have low costs, fares come down or demand goes away, you can sort of hold out for a while. And if you've got the balance sheet, you've got the wherewithal to sort of get through any down period of demand and also take advantage of opportunistic growth. We've got the balance sheet capacity to go buy planes if there's growth potential ahead of us.

That brings -- a great question is, so how do you define your kind of growth potential? And I would be remiss to not address the -- how has it changed during the pandemic and especially in this current environment where fuel is just marching up every day?

Yes. The fuel thing is an interesting concern. We're going to talk more about that. I think it has changed a bit for us through the pandemic, #1. We're a heavily leisure-oriented carrier already. So probably 70% of our traffic is leisure-oriented just by volume. That's obviously been the demand pool that's come back the quickest and strongest, I think leisure demand is above pre-COVID levels at this point, if you ask me that. And we have really focused more on leisure flying as we've relooked at the network and we set some things, mostly out of California. I think we've dialed back some of the business markets in California, connected California into our Pacific Northwest strength cities and really focused more on serving the leisure end of that market. In terms of go-forward growth, one of the things we wanted to make sure we were in a position to do is take advantage of the recovery. We have a history of growing rapidly out of downturns through recovery cycles, and that's why we placed the order with Boeing. And that allows us to both go to a single fleet and grow significantly over the next 5 years if the economy holds up. And so I think that's what we're watching now is oil prices and less about the impact to us and our cost structure. We'll be able to manage through those, I think, in a reasonable way. But the impact on the economy is the question, I think, that we all have now as they continue to soar and haven't sort of stabilized yet.

Yes, that's a good point. And maybe did you want to touch a little bit more about the fleet transition and what you're doing there? And I know you recently provided a little bit more color on the MAX fleet here.

Yes. Yes, we inherited a fleet of Airbus aircraft with the Virgin America transaction, and we've gotten to know that aircraft really well. The 321 is a phenomenal aircraft. Prior to that, we were a single fleet operator. And I think our view is having a single fleet simplifies the business. It allows you to have the most efficient cost structure, both from an asset productivity and a people productivity perspective, but to focus really on operations and not on swaps and repairing operations and having crews in the wrong place and claims in the wrong place and 2 manufacturers and potentially 2 engines. And we just like the simplicity. And I think if we look around historically in this industry, all around the world, the most successful operators are single fleet operators. And so we made the decision during the pandemic to rapidly move back to a single fleet. We have to get out of 70 Airbus aircraft. We're well on our way to doing so. The time line is probably '23, '24. We're thinking about if we can speed that up at all would be great. But in the next year or 2, we should be back to a single fleet of Boeing aircraft. And the aircraft we're bringing in are phenomenal. People love them. Our customers love them. Our crews love them. The MAX aircraft, it's quiet. It's a really nice ride. They're beautiful interiors and they're 15% to 20% more fuel efficient on a per seat basis than their predecessors. And at the same time, we're upgauging. So I think our gauge is going to go up 2% to 3% as we go through this as well. A lot of our Airbus are 150 seats, and we'll replace those with 178-seat or 189 seat -9 or -10 aircraft. So we'll get a really nice benefit of gauge growth, grade-related ASM growth, which we all know is really bankable in terms of returns, super efficient, very little additional operating costs in order to take 10 or 20 more folks. So big revenue upside and about the same trip cost between the different variants, the -8, -9 or -10. And then those MAX aircraft are 20% more efficient than their predecessors that they're replacing.

And just to follow-up on the -- you said fuel is not as much of a concern here or you can manage through. I think you have some hedges there to also kind of blunt that.

Yes.

And if we do get kind of a demand slowdown, what happens with the fleet transition, do you speed that up?

Yes. Yes. And I don't -- I mean, fuel, we do a weekly forecast of our business. We see that fuel price go up every week and it's sort of not fun to look at. But we do -- we are hedged for 50% of our consumption this year. I think we and one other carrier are hedged and most of the rest aren't. And then our fleet is relatively young. It's 9 years old or something like that. It's relatively fuel efficient. As I said, we're trading out the 150-seat aircraft for larger ones. So we have a fuel -- an increasing fuel efficiency benefit coming. So I think we feel like we'll be able to persevere through the spiking fuel and we've got the balance sheet to help us do that from a liquidity perspective. And so I think we'll be -- we're not going to have to pay it in terms of our strategy. What might we do if demand dries up or pricing starts to not be as strong, that would be the first thing we look at, is accelerating the fleet transition out of the Airbus. It just makes sense. The quicker we can get to a single fleet, the quicker we can realize all the savings associated with doing so.

Makes sense. And the other thing that you mentioned, too, is leisure VFR back to pre-pandemic, that is maybe even above, which has been, I think, the surprise for everybody is how quickly that's come back. But the biggest kind of I think the argument in the industry right now is what happens with business demand. It sounds like you said about 30% of your traffic was business before the crisis. Like, what are you looking to see? Where is it today? And what happens if you don't get a full recovery here in the next kind of 6 to 12 months?

Sure. Yes. Yes, on the VFR thing, book early, get your seats early. I've been booking a lot of travel, and I'm in a lot of low-30 middle seats, even like 2 weeks ahead of time. So people are definitely wanting to get out and travel and go on vacation and see friends and family. On the business side, it's been interesting. Every time we've had a wave come down, the business traffic return has been pretty robust. And you've heard us say this multiple times through the last couple of years. And so we kind of anticipate it's going to be probably less than pre-COVID levels, but not really that much less. I don't think it's going to be impaired by 20% or 30%. I don't have a crystal ball. I really don't know. But we just -- talking to our accounts and talking to the folks who travel on us a lot, there's a lot of desire to get back on the road and travel. We'll see if company policies kind of support that. For Alaska, specifically, I'd say a couple of things, Savi. One is, we have an incremental opportunity to capture more business traffic than we did pre-COVID with our entry into oneworld and our partnership with American, the WCIA, West Coast International Alliance. That's allowed us to start doing joint corporate contracts with American that we just couldn't participate in prior to our partnership, which gives us access to traffic that would have not ever considered Alaska just because we didn't fly enough places. We didn't have some of the 100K tier type programs that road warrior-type travelers need and want. We have all of that now. So we can take anybody anywhere they want on one of our partners, ourselves. They get status across the entire family of oneworld carriers. We're doing joint contracts. Today, there's been a high demand for those. And then we started to work with Amex Global Travel as well. We've talked about this in a couple of earnings calls. We've never participated with them in a direct partnership. And so we're now participating with them for the first time. And so I think we've got an opportunity to participate in new traffic that we didn't have before. So I think our business traffic is going to go back to pre-COVID levels or better. And because we don't really need really high $2,000 transcon fares to make our business model work. Even if the yields on business traffic are down, my guess is how they mix into our yield base, it will be net positive ultimately. So if we get a little bit more proportional business traffic as we come back even at somewhat depressed yields from pre-COVID, they'll still be really good for our business.

Makes sense. And just kind of talking about pre-pandemic. Have you seen any behavioral changes in kind of how consumers are purchasing or buying these days?

For sure. The booking curve, it's not just changed. It changes like routinely now. And so it was super predictable, probably for 20 or 30 years. You knew exactly when the booking periods were going to be for the peak travel periods. You knew the periods you needed to focus on stimulation and discounting, and that's all been upended. And so the best I can tell you is they follow the waves. And when the waves are going up, people aren't booking a whole lot. They're focused on keeping themselves healthy and wondering how long this wave is going to be. And then soon as it peaks and comes down on the other side, you see a return of demand that comes pretty quick, the faucet opens. And so you just have to be, I think, more nimble as a revenue management -- from a revenue management practice point of view. And I think it's important to not panic and assume that, that demand is not going to come back. It's just going to be on a more concentrated sort of booking curve. And so I think we're getting more patient as we go through these waves. We're not sort of pulling the discount lever as we did early in the pandemic often. We're sort of assuming that all those folks who were going to book 2 weeks ago will come back to book in a few weeks, and they have so far. And I think as we look at exiting Omicron and going into spring break in the summer, demand is there, all those sort of bookings that didn't happen in the first couple of weeks of the year have come back and the pricing has been good on those. So I think the RM teams are getting smarter as we've gone through this.

Yes. So that's another question I had was with -- you don't have this history anymore because it's been disrupted. And you also have now a change in the industry where you don't have change fees as well.

Yes.

And so what's the risk of kind of mismanaging the pricing in the peak periods. And now you're seeing your competitors starting to evolve as well.

Yes. I think I would have been nervous had you told me a couple of years ago, you're going to lose the benefit of the historical booking curves and change fees as a gate to keep folks on the planes that they originally purchased tickets on. But I think as it's evolved, we've actually become more disciplined. And there's a bias towards sort of focus on yield and making sure you get the right yield mix on the plane versus just heavy, heavy load factor emphasis, which I think the industry has always been focused on filling planes up first. In the early days of the pandemic and those sort of initial waves, that came down and we all thought it was over. We had lost a ton of bookings, everybody discounted aggressively just because that was our safety net. You wanted full planes. And I think, again, as we've gone through the last couple of waves, us and I think the industry has been more disciplined about just -- it's a different environment. The booking curve is different, but the demand is still there. So you just have to let it naturally materialize. So I see more discipline in the RM teams and actually a requirement that they get smarter about how to make these decisions, which is a good thing over time. And they've been able to practice in an interesting period of time where the results weren't sort of going to be measured as aggressively like they had a chance to not get it right a little bit over the last couple of years. So I think they're doing a really nice job this year with it.

Makes sense. And moving on to kind of from the revenue side to the kind of the cost side, a lot of U.S. industries have seen staffing issues and even pre-pandemic, I think the airline industry was seeing tight supply from the pilots and kind of mechanic standpoint. Like what is Alaska seeing from a staffing standpoint and your kind of comfort and your ability to grow?

Sure. Yes. Initially, the shortage was really on, I would say, the ground side of the business ramp, a little bit of CSA. And I think a lot of that was just related to the support that was put into the economy, the other forms of income people were able to go and avail themselves up to the pandemic and pandemic relief funds, which was critical. Like, we're happy that people have access to that. But it did mean that labor pools are a little slow to come back to work. That's no longer an issue. I think it's still tight, but we're seeing a stabilization of applications and sort of attrition in those ranks. I think pilots and mechanics, those are the 2 that are going to continue to be an area of tight labor supply for the foreseeable future, probably a couple of years, really driven by the inordinate number of retirements that the industry sort of had as part of their COVID stabilization plans. And I think something like 10,000 pilots retired early over the last couple of years. And just the sheer number of replacing that many pilots, there's only 16,000 regional pilots in the entire country. We just know that that's going to be where the bottleneck is. Training, we are at full capacity on training. We have increased our training capacity. But there's a limit to how many folks you can train in a given month. And so I think for us and most of the other carriers, the pilots are out there. It's just for the mainline side, getting them through the training cycle that's going to be the hardest part. The other thing I would tell you is attrition. New hire attrition for pilots is actually lower than it was pre-pandemic. That volume we're hiring is so high, it's still significant material. So we might -- for every 100 people, pilots we hired pre-pandemic, lose 5 to 10 of them, and they just make different career traces. They decide they don't want to live in Seattle. They do that at other airlines and come to us. That's a normal sort of mixing that goes on. We're seeing less by percent, more by volume because we're hiring more people. And so on the margin, it's not a material driver of concern for us in terms of capacity. But on the margin, to get that last block hour up in the air, it becomes a little bit harder to do until that stabilizes. The regional industry, I think, is going to be the one that is challenged the most. It's challenged the most today. I think most of the regional operators have cut block hours by 20% to 30% as their attrition rates have doubled to triple from normal. And that's going to be with us for at least 12 to 18 months would be my guess. Everybody is actively working on pipelines. There are a lot of pilots in the pipeline to come into the regional business. And so I don't think it's an issue that's going to be around for 10 years. But I do think for the next 18 to 24 months, you'll have some lower regional capacity lift and you'll have really high sort of throughput capacity in terms of new pilots at mainline and that ability to get new hires through the classrooms will probably be the limiting factor on growth for a lot of folks for a little while here. But it will clean itself up, I think, in the next 24 months.

And I think you have a regional operator within and you work with a third party as well. And I think about 10% of your capacity. So this would apply to your capacity as well.

Yes. That's a good call up, Savi. So 90% of our lift is mainline, 10% is regional. And we've got 2 suppliers of regional, SkyWest and Horizon. Horizon is a wholly owned sub, and they provide most of our capacity, 65% or so. And they're both received -- both SkyWest and Horizon have similar attrition rates, and that's impacted the block hour similarly. Again, it's not -- it might be 1 to 2 points of capacity on the margin for us, a lot of which can be carried by running our mainline operation harder. So I don't think it's going to be -- it will be an issue, and we'll be talking about it. I don't think it's a long-term or even a medium-term sort of structural issue for us.

Makes sense. We have a question in the audience.

[indiscernible]

Yes. No, it's a great question. The question was about the 10,000 pilots who retired, assuming they were at the highest pay rates in the industry. And generally speaking, I think that's true. I should just be super clear, most of those were not Alaska pilots, right? So we weren't as aggressive. We early retired about 170 pilots from our company. Most of those came out of the legacies. So our average cost from a pilot perspective hasn't changed a ton. As we grow and we bring new hires in at the early part of the wave scale, I think we'll have sort of a flattening or even maybe a slight downward pressure on average wages. I can't speak to the others. I will tell you they have to remix all of their pilots because they have to now upgrade a bunch of people onto those expensive aircraft. And so everybody is going to go up on some more expensive aircraft and then they'll backfill, obviously, on the most -- the least expensive aircraft with the least expensive people. So I don't know how profound of impact it will have on their properties. But certainly, they should enjoy some average wage decline for a period of time until that those folks start to grow through the scale again.

And maybe turning to inflation, which on the other costs, it's been a big concern for -- prior to the -- last couple of weeks, there's been a big concern. Could you talk about what type of kind of areas that you are seeing inflation -- higher than normal inflationary costs? And which areas might be unique? And what levers do you have to kind of offset that?

Sure. Yes. And the first thing I think, we're nervous about it just on behalf of families and workers in America. I think it's especially sort of at the entry-level part of the economy, people were enjoying wage gains that are now being completely eaten up by inflated prices. So that's depressing to us, and we sort of feel for those workers and families. As a business, fuel is the most prominent place, obviously, that we're going to feel acute sort of price increase. We've been feeling it on that entry-level wage sort of pool we've shared in the past. On earnings calls, we sized that at something like $25 million to $30 million of impact a year. That's structural that we assume is going to be with us for a long time. And that's -- it's a real cost increase, but we are happy for the folks who are getting those additional wages. And it's not -- it doesn't structurally change our business. We can be successful even in an environment with higher wages on the entry-level side. The rest of the business is, for now, a little bit immune to inflation just for a short period of time because most of what we buy is on fixed contract, and it's -- the prices have been set by contract a while ago, and it's going to be a little bit of time before suppliers are going to be able to come back and ask for increases. We know it will happen. It will probably happen in sort of ratably over the next 18 months to 24 months. I think on the technology side, including distribution of tickets, which is a large cost center for us. I don't anticipate a ton of pressure there. Those companies have been doing relatively well throughout the pandemic. I think it's anything that's got a heavy transportation or wage labor component. So suppliers who supply food and beverage, those sorts of things, we are seeing their prices or their costs start to go up and that will come into the business as well. Our biggest hedge against that, again, is getting the fleet, efficient single fleet, making sure we have high asset productivity, running planes hard, running people hard. That is always going to be our biggest sort of edge against inflationary pressure. And then the last thing I'd say, all of our big CapEx expenses, engines and airplanes, they have escalation in them, and so we'll see higher prices for that CapEx. But they're capped, and they're capped at levels that are very reasonable for us. So I'm not too concerned about the effects of inflation on our capital, cash flows either.

We have question again.

Your current mix for owned versus leased, how do you think of those overall?

Highly prefer owned at Alaska and have historically been 90-10 or better. Virgin in the acquisition was predominantly, 60 of their 70 aircraft were leased. And so part of getting back to a single fleet is getting out of all of those leases will replace almost 100% of those with owned aircraft. We did do a transaction to lease 11 or 12 aircraft in order to have somebody purchase the 10 owned Airbus aircraft we acquired. So at the end of the day, I don't have the exact count in my head, but we'll be better than 80% owned and on our way up from there. We highly prefer owning the asset. I think it's better to the P&L. It's better to long-term returns, and it gives us collateral to go borrow against in a sort of a downturn period.

And I do want to open up for the questions. If you have any questions, feel free to raise your hand.

Do dividends ever makes sense for the industry? Or is it better than just buy backs? [ Have your thoughts changed to invest over the past year, just that one capital allocation? ]

Yes. No, I actually asked this question -- oh, I need to repeat the question. The question is do dividends make sense for the industry? Or is it better to buy back shares. And it's a question I ask our owners and investors from time to time as well. I think when we did it, we were really focused on becoming a high-quality industrial type company. And that was a hallmark of those types of companies. If you look at the industry predating that, we didn't -- we are an industrial, but we didn't behave like it from a shareholder return perspective or a return on P&L perspective. And Alaska had done a lot of work under Brad Tilden to become a strong business, have returns that were well in excess of the cost of capital of the business, outperform industry peers. We got -- to do all of those things, we did a really good job with that. And then the next thing was how do we do shareholder returns. And to us, dividends was sort of a mark of confidence in our ability to continue to perform as a business and create free cash flow. So it's very much in our mindset because of what it represents. It represents our belief in the stability of the business. I would not be shocked at all if we didn't return to a dividend form of capital allocation at some point in the future. You hate to turn them off. I think if there was ever a reason to turn them off, what we went through was the right reason. But I think they can make sense because they drive the management team to really ensure that you try to create a stable sort of platform for creating free cash flow in the business. And we do like the flexibility of share repurchases. But I don't know, for us, having some of our shareholder returns that are fixed and sort of just on a rhythm, we like that mix as well. So no decisions. We haven't been deeply thinking about this question recently because we're still restricted from doing any form of shareholder returns for a few more quarters, but we certainly understand it's on the minds of investors too.

Okay. Maybe one last question. Just industry oversupply has always been a concern. Could you talk about for current and future shareholders over the last -- how should they think of Alaska in the context of oversupply concerns?

Yes. No. Well, one thing, I've heard industry oversupply as a concern for the entire 21 years I've been in the business, and Alaska has grown 5-ish, 6% compounded over those 20 years. And so we are certainly cognizant of the growth plans of others. I think if you look at our geography, where we have sort of naturally won over the years and have a right to continue to win, it's not a place that people have focused a ton of competitive pressure on us, except in the sort of buildup that Delta put into Seattle. I think we handle that really well. And I think we've come out of that as strong as anyone might have expected. And as strong as we've ever been, we had some of our most profitable years after they came into the market. And so I go back to like when we have costs that are on par with LCCs and product that is on par with a legacy domestically, it's just a really good value proposition to have. We can offer people a phenomenal loyalty program, really, really nice product in the plane at a price that you would get on an LCC, and we can still make money at that. And so it feels like if there's a company that can manage through a high-growth period of the industry and do it in a way that is responsible and still has reasonable returns to Alaska's business model is one that can do that.

Okay. With that, thank you, Shane, for joining us again this morning. Very early for you. There is a breakout in Cordova V for additional questions.

Thanks, Savi. Thanks, everybody.