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

Let's close out the conference strong, and we can do that with some airlines content, and we are very happy to have with us Alaska Airlines and CFO and EVP, Shane Tackett. Shane, thanks so much for joining us. Just I think flying in and out for this, much appreciated.

Yes, of course, happy to be here, thanks for having us.

Great. So before I kick off, please note that for important disclosures, please see the Morgan Stanley research disclosure website at morganstanley.com for full disclosures. If you have any questions, please reach out to your MS sales representative.

So Shane, can I refer from other airlines and obviously, other travel companies at this conference, and I think just -- the key sense is to try and figure out what's going on right now. So maybe a good place to start would be to just give us a little bit of update on what you're seeing in terms of demand and the travel trends, obviously, extremely strong for the last 12 months, and if any signs at all of cracks. I think the market may be trying to will ourselves into a recession at some point, but it feels like travel is fighting back really hard.

Yes. I think your sense is completely accurate. There's been really nothing that suggests that there's been a turn in demand for travel. I think we said on the call, and I said it in the interim, like we're going to have a strong summer. Like people -- I think, in fact, we were just pulling some data or -- a couple of days during Memorial Day where the third and fourth or fourth and fifth highest passenger from volume since the pandemic began. Certainly, there's more capacity in the year relative to last, but it's all getting filled. Look, we're all thinking about and looking at and sort of anticipating what happens post summer and into the fall. And if the market does a good job at willing itself into recession, what that means for us. But right now, we're just trying to capitalize on the demand we do see, which is quite good.

So again, there's a lot of talk at this event so far about differences in demand by demographic, by end customer, by geography, kind of any patterns or any differences at all that you see out there? Or is it just one big model, big block of strength?

Yes. No, I think it's more a big -- I think everybody wants to go places right now. Just anecdotally, even in friend, networks, family and people we sort of talk to regularly in our personal lives, there's not -- they're still planning trips. They're planning trips into the fall, into the winter. I think people have enjoyed getting back out and that hasn't changed yet. Certainly, you guys know this, the West Coast is probably the least recovered in the country. Certainly, business on the West Coast is the least recovered. And we're still full, and I think we're doing a really good job with financial results. So I sort of feel like there's more upside to come for us, particularly just because the West Coast will recover at some point, it's going to get back to full pre-COVID strength, business travel will return, and that's like all of that upside for us eventually.

A great segment to my next question, which is what are you seeing out there? Obviously, kind of tech is challenging given some of the cuts there. We're maybe starting to see consulting come back and we had some consultants here yesterday saying that [Indiscernible] -- so any signs of life at all on the corporate side?

Yes. No, it's really still at the 75% by volume...

Which is better than a lot of people thought it out get up...

Yes. And I think the split is like small, medium business is over 100% recovered and then really large tech is like very depressed still, 90% by revenue. We've sort of talked about at least fiscal years clip and a lot of tech is December, January, start fiscal year, but summer midyear, a couple of big ones in our network are. So we'll see -- we believe, based on what we're hearing from them that they are going to get back on the road to see customers and that they're going to continue to limit the intercompany travel type of stuff, but really return to almost normal in terms of getting out to see their customers and service customers. And so I think -- look, if it doesn't come back in the next 3 or 4 or 5 months, it will be fine. But if it does, that will be a nice story we'll have to tell through Q2 earnings call or some other form as we see it materialize as we get through the third quarter.

Got it. And obviously, you're largely a U.S. domestic, kind of near international airline, but kind of -- how do you think about the international recovery, whether it's South America or Asia and the connectivity, especially now we're part of oneworld. What does that mean in terms of potential new opportunities for you guys versus before the pandemic?

Yes. Well, maybe a couple of things. One, we're excited for our partners that they have got traffic throughout their networks. I mean that's really all of the oneworld partners, but certainly American. The international folks have had the hardest really net-net over the last 3 years. So we're excited for them. I think maybe we were like curious, like if everybody goes international, whether there be enough demand domestically? And there was. So we're thankful for that and happy about that. And yes, I think we are starting to see the beginnings of really unlocking the oneworld partnership. So we'll have a big piece of that as selling our partner tickets, and that is just starting to happen. So I think we've got 6 or 7 partners who are now selling all their cabins, and we'll have 10 by the end of the year. And look, we -- I don't think we've quoted numbers, and I probably won't share specific examples today, but there's -- there are certain partners certainly in Seattle where we're flying the 40%, 50% of their plane in terms of our customer base getting on to those partners planes to go international. So it's been a lot of Europe, honestly, and a lot of -- on us, even down into Mexico. But we're pretty strong in the markets we serve, in Central America as well. But we haven't -- I think we're still waiting for Asia, for China and for some of the other non-European destinations to really pick up, which they will.

Got it. Is there any deal on the loyalty side at all from -- again, there may have been some people who may not have been onboard the Alaska train, plane in the past because of the lack of international connectivity, but now you do. So have you seen any pickup there at all?

Yes. I mean it's -- I wish we had data that was really clear on this, like the sections from others. I don't know that we have that sort of data. But what I can tell you, and we've shared this, I think, relatively regularly in earnings calls and our loyalty sign-ups and our credit card acquisitions have been much stronger than I think we even thought was possible. And I think that's been a general trend amongst a lot of airlines, but I think we are outperforming others. And it kind of makes sense. If everybody is at a basic -- sort of baseline level, we should be doing better because we've got oneworld that didn't have pre-pandemic. We do think that's driving a lot of it. And that was the whole thesis. If we can keep our customers and our ecosystem, give them seamless travel throughout the globe and sell them tickets on alaska.com, there's no reason that they would be going to another carrier. So our basic view is it's working, will get tighter and tighter on proving that to ourselves and then talk about it more as it matures over the next few quarters.

Got it. Another big topic this entire conference has been changing patterns, whether that's seasonality or consumer behavior. I think from some of the previous airline discussions, there was a view that, hey, seasonality is starting to come back, but it's not what it used to be. So from your vantage point, kind of what is -- do you know what the new normal is And kind of how different is that versus the old normal?

I'm always smirking because it was after -- like some people declared that there was no seasonality anymore. Every day, was a strong day. No, I think we largely believe long-term seasonality will return, but some durable changes because of hybrid and flexible work schedules. So we still see a lot of strength on Fridays and Sundays, which wasn't the case pre-pandemic. And I think those are durable. I think you see the holiday seasons be a little bit more spread throughout the week because people aren't adhering to like, I got to be back by Sunday to be out on Monday, so they might come back on a Tuesday or Wednesday. So you're seeing this holiday periods be a little bit more extended. So I do think this idea, like the strong demand periods are going to be incrementally stronger because people can come up -- come back on multiple days versus everything on Sunday or Friday or whatever. Those are probably durable. I think those are probably structurally going to be with us for a long time. But the basic overall peak, trough shoulder period, I think we largely have seen that pattern return, at least in our network. And we probably have one of the most peaky seasonal network amongst the airlines.

Got it. So again, there was some talk in an earlier session about higher peaks and kind of the trough being not as strong as '22, but probably similar to '19 and already see things [Indiscernible].

Yes. I think that's true. I think what we're not certain about is how much of our trough performance was due to the business travel being not -- so we'd like to see a period or 2 where there's relatively full return of business travel to see how those trough periods play out. I think our hypothesis is they won't be quite as bad as they were this year. But certainly, the peak are -- peak year are stronger than they were historically, and more than offsetting those weak periods. But I think our belief is those weak periods will do a little better as business travel comes back.

Got it. Moving on from just demand to yields, right? Obviously, it's been a big focus area for most investors, but also kind of the general public, right? I mean the airline analysts and people keep coming to me and try to beat me up about how expensive our vacations are so -- so my fault, I promise. I actually prefer to [indiscernible] airlines analyst. But what's your view from your seat? And do you feel like this is -- I don't want to use the B word, but I mean it doesn't feel like a bubble, but kind of -- does it feel sustainable? Is the new normal at where it should have always been? And where do you think yields go in the next kind of medium term?

Yes. I mean, this is all opinion, right? In my opinion, I do think net-net, we've probably reached about the most people are willing to pay. Like there's going to be pockets where it will come down, pockets where there's probably more room. But yes, I think we've sort of gotten to the level of resistance or something. And the good thing is it kind of works for the industry right now, like given the cost profile of the industry and where oil is, the current revenue environment, we can still run a healthy business and sort of balance what we need to do as a company strategically. I personally think they'll be more sticky and durable. I think there are real supply-side constraints that are going to be durable for multiple years. I do think that just pilot supply, aircraft manufacturer, production rates, engine -- production rates and engine overhaul capacity throughout the industry. There's just some things that are going to like require capacity to be moderated relative to sort of where we were pre-pandemic. I do -- my sense is we probably underpriced the product for a long time. I mean people didn't all of a sudden decide it was that much more valuable to travel. They probably were willing to pay a little bit more than they had prior -- and my sense is consumers are generally adjusting to the new normal. But it's not just in air travel like inflation has sort of hit a number of different parts of the economy. The good thing is wage growth has been good too. So I think there's -- to the degree it's like getting consumers harder, they do have more wage to offset that.

And they're prioritizing travel over other spending.

I will agree with that. So we're relatively optimistic that it will fluctuate a little bit. I think it will very modestly soften from the peak, peak, but I think it's relatively durable [indiscernible]

Got it. So let's move on to the top line to kind of just operational stability and reliability. And obviously, you guys have not been without your challenges over the last 2 years, like everybody else among your peer group, but on average, you've probably been better than almost every other peer. So how are you seeing, a, resource levels across the organization, b, there's a lot of concern about what the summer is going to look like. Again, [Christine] and my team currently is at [JFK] and she's saying it's not [Indiscernible] there right now, and it's like early first week of June. So how do we ensure operational reliability through the summer? And what are the fallbacks you have?

Yes, I landed at 2:30 or 3 yesterday in Newark, and I hadn't seen that many people in airport, all getting ready to board, like they wanted us off the plane, they want it on, and it was a lot of people. But look, just for context and going back like we were just looking up this data. We tried to grow the company by volume 25% between Q1 and Q2 of 2022. And look, in retrospect bad decision, right? Like just not possible. It's not because I don't think these businesses on a large base, they don't really grow more than 8% or 10% maximally.

Quarter-over-quarter.

Yes, quarter-over-quarter, and so I think it was like ambitious, I think we had believed that we have put all the plans in place and we just flat out -- got some things wrong. I think we've learned a lot. So May, we had the industry's best completion rate. We are at or above -- in fact, we're holding, generally speaking, more resource then we technically would say we needed based on normal metrics. But we've been talking about that for a few quarters. We're going to get ahead of the curve. We have to stabilize the operation. It's like the first commitment to customers, and it's the only way you start to lean out your business. So you got to get the variability out of the operation, stop canceling flights. By the way, when we plan for 25% quarter-over-quarter growth, we grew at 12%. So -- it was still a lot of growth, but it was like nowhere near it. And we've really moderated that. We're now just now flying 2019 levels in terms of volumes. And I think a lot of lessons learned from last year. I think the ops teams and the HR teams are doing a phenomenal job. There's not really area that we have resource shortage today. There are certainly areas we're super focused on, regional pilots, pilots in general, mechanics. There are parts of the industry that are still sort of stressed from an ultimate growth standpoint, are there enough resources out there as we continue to grow from here.

Got it. And so just on that point, kind of how are we looking at the near-term cost outlook kind of through '23 and maybe even beyond that? I mean, obviously, you guys along the rest of your peers have had the resource up before and it's like fill that -- kind of back into that demand, if you will. Cost inflation has been a huge problem kind of obviously, kind of the pilot situations now resolved. So how do we think of the near-term outlook in terms of the cost side?

Yes. And I know analysts and investors appropriately so focus a lot on costs, especially with us, it's been sort of part of our DNA historically. Look, we missed the midpoint of cost in Q1 by like $7 million or $8 million. I do wonder sometimes if people overweight that miss on a $2 billion or $2.5 billion base. We are getting that muscle back. It all starts with operational stability. Once we had it, we can start to wean out the resource model and the operation. And we'll do that really by adding more flights, not taking people away from the operation. But we're going to do it in a measured way that we don't want to see a falloff in operational performance. But this year is really the clearing year for us. We've got -- all of our labor deals should be done. We've got a couple weeks, we've got to get done flight attendants and mechanics. We will be through the full flight transition, not only the Airbus is getting out of the P&L, but like all of the pilot training, getting through the process as well. So we're really looking forward to a clean sheet next year and almost any reasonable rate of growth unless there's a big sort of surprise cost category that hits us that we're not anticipating. I think we are set up as well as anybody or better than most to leverage growth next year into better unit costs. This year is going to be up and down a little bit. You guys are going to -- as you should hold us to account for guides and for tightening, but -- they're still with Airbus and with the pilot training and labor deals and something implementation of labor deals, there's still some things in the -- that are noisy in this year. But I think we're going to have a good year ultimately. I think we're really well set up with continued up gauging and all of this other stuff I just spoke to behind us to have a strong cost during next year.

Got it. So at the Analyst Day, kind of you guys have laid out $400 million of incremental revenue opportunities. Obviously, you've been cranking away that in a number of the different buckets that you were supposed to get there. What innings are we kind of through that process, kind of have you identified more opportunities? Again, analysts always want more -- when do we get numbers.

Yes. Yes. I think -- so here's the thing. I think we're well into like we're over halfway through all of that. I think we want to hit full, full run rate by next year. It's funny because I said at Investor Day in May -- May of last year -- March of last year and said these are measurable and then yields rate. And so it's like -- it's hard to measure when your entire baseline, yield have to go at 15% to 20%, and all of the underlying revenue averages that you are using have got changed. So we're sort of making sure that we fully understand that we've captured all of that. But the up gauging is absolutely -- that was a big piece of it. We are now merchandising first-class PC in the booking path in ways we haven't done before. We've been talking on calls about the rate of the first class cabin and the PC cabin that we're selling with sort of the highest percent sold rates that we've seen in our history. And we're doing that at increased yields oftentimes in those cabins. So we know that, that work is working. We just started to sell exit rows very quietly. Over the last several days that was one of the other smaller items that were in that road map. And then we have the new big deal done, and that has proven to be -- those economics aren't really yield sensitive, but they've been better than what we announced at Investor Day. So I think we've done a really good job. We've -- I think we've generally arguably outperformed industry, which we should with all of these revenue initiatives, some of which are just catching up to what other people have been doing from a revenue perspective, especially given again that our business sort of backdrop and the West Coast is relatively less recovered than everybody else. So I felt good about our revenue results given just the exposure to the West Coast that we have.

So maybe a little bit of a slightly forwarding question, kind of it feels like 2024 is going to be the first fully normal, nothing weird going on, macros okay, no wars, I don't know, no pandemic.

You said it. You said. I'm with you.

So can you guys get more proactive and more front-footed kind of -- I don't want to think going after share because that sounds bad, but in terms of just new opportunities, new routes, just new -- again, we've already spoken about the incremental revenue opportunities, but a lot of that was just refining efficiency, kind of cost [Indiscernible], right? So can you be more front-footed in '24? And what are some of those opportunities, you think?

So I'll say two things. I know it's a little stale and maybe even borderline boring. But our first sort of order of business is depth over breadth, right now. So we have a lot of markets that deserve an additional frequency or 2. And generally speaking that's better growth, right? Than speculative of new market growth. So we're going to be disciplined. We talked about this at Investor Day. We're going to really focus on making sure we get all value we can in our areas of strength, which we put a lot of incremental capacity into Seattle. We've got to go build out Portland. And then we've got to start adding frequencies to markets that we know could take those additional frequencies. Having said that, I do think like if we had a do-over for Q1. We were way more sort of like anticipating business recovery, and probably left some leisure demand on the table. And we're going to be very thoughtful about how we configure the network in Q1 next year in anticipation of more balance towards leisure, most likely. Still going through that, really early days, don't have markets to share at this point. But just philosophically -- we said something -- Ben had sort of made it a challenge of the commercial team to get out of the loss-making January and February. In fact, it's all 6 weeks in Q1. [Indiscernible] are made every other week, that's fine. But there's a way to contour the network, I think differently to give us a different result in Q1 that may result in some other leisure destinations or maybe it is just more frequency. But that's a really good question. I'd keep asking us as we get through the next couple of earnings calls.

Got it. Just want to kind of shift gears and look more long term, 3 major aspects. First one, I'd say, is tech. I mean, obviously, AI is kind of a huge bubble right now. I'm not going to ask what AI means, maybe I'll ask you, fine. What can you guys do with the AI?

How do I get an AI multiple.

That's what I want to -- you tell me...

First take your revenues to 0.

Okay. No, so a, that, and b, kind of -- obviously, this industry has been under a lot of scrutiny in the last, I'd say, 6 to 9 months about tech spending and just kind of maybe some of the more basic systems, whether it's the FAA or kind of some of your competitors that have had some operational [Indiscernible]. How are you guys looking from a tech investment standpoint, where do you need to add more resources? And kind of is that a 2- to 3-year thing? Is it a 5 to 7 year thing, how do you...

Great. One thing, we -- I'm knowing circa like mid-2000s. We have the exact same IT budget for like 8 years at the company. Early 2010, we were like, okay, we got this, doesn't work. We started a big step-up in IT spending around '13, '14. A lot of modernization, hardening, not really sexy stuff at all. Then we did Virgin, another step up, integrating the two companies and then starting to refocus on like innovation and employee-facing technology and also like sort of reimagining our digital experience at. I think our budget today is 250% to 225% of what it was back in '15 or '16. So we've already put a lot of incremental investment here. I think what you're going to now start to see is much more deliberate focus on the app experience, and then the airport experience as well. So we -- and you know this is really like we sort of got rid of Seattle -- yes, that was huge. We spread out, you go check in somewhere, you dropped bag somewhere else. We probably did as well as anybody in terms of utilizing airport infrastructure to get people through. In fact, there are so many people going through that we muck up the security check. But we're going to do it again. We're going to really work on getting people to come into the lobby with their boarding pass already done. Those who don't need to go see somebody get straight out to the security checkpoint. So to need a bag we're actually getting rid of kiosks. We're putting single-purpose iPads in essentially 10 QR codes spit out of bag tag in seconds. And then we're working on some way of having a self-baggage sort of induction. We want to get people through that lobby in a few minutes. And it used to be like 45 minutes to an hour during a peak day. So we're going to be very focused on the customer experience at the airport, especially in Seattle. It's a constrained footprint already. And I think we're partnering well with the airport about what to do once they're through the lobby and how you get them through security. And there's a lot of constituents on that side, but a lot of focus on making sure that's a good experience as well. So I think you'll see us much more on the innovation side, customer facing innovation.

Can I follow up on that because that seems pretty fascinating to me. I don't think anybody else has tried that. And how has that been received? I mean, are customers like super happy they can breeze through? Are they like what the hell...

I've been waiting for like the major -- like rollback, and like get the cards and bring -- like the kiosk back out as there was customer -- no, it's actually been really -- that's well received. I think it's in 7 or 8 stations now. We did small stations first. [Indiscernible] sort of first hub. And now we're partially implemented in Seattle. There's a lot of construction in our lobby in Seattle in the next couple of years. Yes, there are certain people who walk in there like looking for their full-service kiosk and it's not there. But as soon as they sort of get the hang of it, like everything that you could do on the kiosk, you can do on the phone before you get to the lobby, and I think to get the friction out of the process, you got to separate where work is being done and where passengers are doing self-serving versus meaningful service. We'll continue to allow our guests to go meet with real people if they want to get a full service experience. But I think we're seeing really good adoption in the markets that we've rolled it out. We haven't got the drop your own bag technology yet. That's all in prototype, but soon enough lot of that going as well.

So you're working on that too.

I think -- obviously I'll just say one thing we're excited. I can't tell you like where exactly the right use case is. I can tell you that we're quickly going through a process of identifying initial use cases. So we can start to get smart on this. We are very, very fortunate that a very strong corporate partner of ours, Microsoft is a leader in this area. We're one of the handful of initial companies that we're going to -- that they're going to partner with to figure out how to operationalize this stuff. You can imagine the demand back up that they're experiencing from the customer base on this. But I think we've got a chance to figure this out relatively quickly amongst industry peers just because of some of our partners that are close by that are really, really invested in this.

Exciting. In the last couple of minutes we have left. The other thing I want to ask you was about ESG. I think it's very easy in this kind of macro and this kind of taped to kind of not look beyond your nose, but I'm sure -- I know that you guys are looking out to 2030 and your net 0 targets, I think kind of preparing for what the industry is going to do there. So I know you were at our ESG conference a couple of weeks ago, but maybe you can share a little bit of an update on how you guys are thinking about the transition to [Indiscernible] fuels.

Yes. Obviously, I've come full. I'm really excited at this point. I think a year -- like 2 or 3 years ago, when we're setting these targets and there's like no -- like no tangible path, like a brain like mine struggled with that. And it's like, wait, are we wasting money? Are we investing in something that's real and like natural sort of like evolutionary at the point of having to pivot to something very different, like, I think, natural reactions that we were all having. [Diana], who was at the conference, has done a phenomenal job leading this effort for Alaska. We're 100% committed to it. We actually have a 2040 net zero goal which is the Amazon Climate Pledge. It's very appropriate given where our hometown is. And look, I think we -- in a perfect world, we wouldn't spend a ton on offsets. We will do that where we have to. They have to be, in our mind, credible local, auditable things that we believe in and others who go and look at it and say, are these really like real carbon offsets like, I would say, yes. More importantly, we'd like to find ways to invest in supply of SaaS. The infrastructure, offtake agreements, partnerships with corporates who are willing to pay some of the premium difference, just getting that market going. And then look, if they ever get carbon capture figured out like we'd love to get exposed CapEx, like I think we would put capital towards that type of technology as well. That's years out. You're talking 10 years from here. I don't know that airlines have ever been good 30-year planners. I mean, like you know this. It's an industry that doesn't lend itself to that. I'm not sure our country has been great at 30-year planning. I think it might actually get this one done. There's going to be a lot of like [Indiscernible] between. There's a lot of like groups competing interest and -- there's a lot of division, but I do think people are starting to realize like, we got to figure this 2040, 2050 thing out. And in a pretty short period of time, you're starting to see ideas converge and sort of animate their way towards like that's where we all need to go and like, let's all get behind it and try to push for it, which is exciting. It will be fun if we pull it off as a country and as industry.

Yes. I mean, yes, it seems like everybody is going in the same direction and kind of everybody has made the commitment. So hopefully, a -- yes. Great. Exciting times, both short term and long term. Shane, thank you so much for the time. And yes, I wish you well this summer. I think it's going to be gangbuster.