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

Great. So to kick off the airline content of the conference, very happy to have with us Alaska Air Group and CFO, Shane Tackett. Thank you so much for joining us, sir.

Thank you, Ravi.

Again, research disclosures, please read them.

Maybe I'll just jump straight into the Q&A then. Obviously, it's been a pretty interesting year, a lot of scrutiny around domestic demand in particular. So maybe -- I know you guys gave us an update last week, but maybe you want to kind of share some thoughts on that and kind of what you're seeing in the domestic environment right now.

Sure. Yes. it has been an interesting year. So like first half of the year, super strong. You guys know that, that's all in the books. I think we saw particular strength close-in that we hadn't expected just because it wasn't business, it was leisure. That started in April and carried through May, June, was with us in July and all the way through August as well. So really no change to pattern for the first couple of months of the quarter. I think September has been more normal seasonally. So a little less strength close-in, sort of a more normal environment. Not concerning at all, but it would have been nice. So we've seen the close-in strength persist. I think last year, there was so much spillover demand out of the summer in September. It was hard to know what we were going to see this year. I do think some of it is caught up in this international domestic mix. We're already starting to see that normalize. Too soon to call it for Q4. But I think our hypothesis was a lot of that international demand would normalize and, ultimately, rebalance itself towards domestic, and we weren't going to see a structural shift in. We're seeing early signs, if that's the case. October, November, December are booking exactly where we would have expected from a load and from a yield perspective. So good start to the Q4 booking curve. Very early, obviously, but no -- nothing that's off-trend from what we were expecting or seeing in the summer. So the one sort of like issue that we saw, and it's modest, was the September close-in demand not carrying over from August. And then last thing, and you may ask about it, but we were certainly impacted by the tragedy in Maui. And I think that will be persistent for a little while. It's a really tough thing that the community is going through there. And so we're more focused on doing what we can to help the community get through it. We'll be anxious and excited once it's really open for travel again. And it's not a huge part of our network, but it did have a relatively decent effect on the third quarter.

Got it. So great color, a few follow-ups there. One is, do you now have a sense of that close-in behavior in hindsight, whether that was an aberration from the pandemic or whether that was a new normal that's just on pause right now because of international or macro or something?

Yes. We had said on the call, Ravi, like I don't think we'll put it into our forecast -- in our guidance because it's...

It's a nice bonus.

Yes, it will be a nice bonus.

Okay.

I think it was with us long enough through the peak period that, at least, that spring through summer sort of travel, I think we would expect it to happen again. I think the real shoulder periods, the Septembers, the Jan, Febs, maybe it won't as much. The problem with putting it into our forecast or guidance is if it doesn't come true, you're just -- you can't perform [ and also the guys ]. By definition, that's the issue with all those close-in stuff. But I do think it's -- maybe it's not going to structurally be as much as we saw this summer, but it felt persistent enough that it could be part of a new normal going forward, certainly, in the sort of really peak travel season.

Got it. So when we look at your 3Q guide and your guidance going forward, you're not going to put that in? Yes.

To the degree we can tease it out, the revenue management team is able to say like this component would be like close-in demand strength, we probably would extract.

And did you see that in like certain destinations, certain type of customers or known behaviors? Or was it pretty across the board?

No. I think all of the markets where we saw strength, it was relatively happening in. There were markets, Ravi, we flew like 98% load factors in July, like Pittsburgh, out of Seattle. Nobody would have guessed at that. And a decent chunk of that was close-in. So it's like -- yes, I don't know. But that was for a whole month, by the way. A whole month, like the plane was full. I think the opportunity is, if it does persist, the revenue management team can anticipate it and do even better on the yield side.

Maybe it was of the Taylor Swift or something.

Yes, yes, as well. Yes, yes. Back into Seattle, that was quite the event.

I can't imagine. And just on Hawaii, obviously, kind of really unfortunate situation there. But kind of, a, can you quantify it; b, can you give a sense of what that curve looks like going forward? Because I think now they're asking for tourists to maybe start coming back because, economically, it would be helpful for the area. So when do you think that reverses?

Yes. Yes, so the rest of Hawaii has been really strong. Kona, Lihue and Honolulu. Right now, we heard yesterday that West Maui is going to open on the 8th of October for tourist travel again. I think there's several thousand displaced residents that are in hotels. So I don't know what the answer to that is. I think we're waiting to see what their answer is. We had like 8 flights a day into Maui, on [ 1,200 or 1,300 ] today, so it's not a massive impact. But for several weeks after the fire, we had net negative bookings lots of cancellations, very few new bookings. That's turned now. We're back into net positive booking territory. I think it's going to be a couple of quarters for it to rebuild its baseline level of sort of traffic and demand. And look, I think there's a subset of people who are going to not want to take this aspirational vacation to a place that's still suffering. So we're going to go at the pace that residents of Maui want to go, and we'll serve the demand once we see it start to come back. But it truly -- the economy is very tied to tourist travel, and they do -- you're starting to see a move towards wanting to go public with inviting people back out there. So a couple of quarters, I think, it should normalize.

Got it. Moving to corporate and the demand side. I have several friends in tech, who are being basically forced back into the office. In fact, some of them are going back to the office at a higher pace than they did before the pandemic. So is this the catalyst, the tipping point that you need for kind of tech to start traveling again?

Because then they want to go out of the office and travel.

I mean, if you're doing it, you might as well get on a plane, right?

Yes. I think, look, nothing's changed for us yet. So we're still where we were 6 weeks ago, 75% recovered by volume. And it bounces around that number right now. We are -- I can tell you, driving in Seattle has changed. So somebody is going back to the office because it takes me 20 more minutes to get to work now. So I think it's early. But yes, we've always sort of connected the two that you would see a greater return to the travel once you got people back into the office. It's certainly happening in the Seattle area now. I think it's going to take a quarter or 2 for it really to like fully take hold. And very similar to the close-in demand thing, we've put no business return in our guidance either. So it's all upside for us, and it will continue to be upside for us. I'm sort of out of the prediction game when it's going to happen. I do believe like we have large accounts, like most valuable companies on earth who were flying at 25% or 30% of pre-pandemic levels. That's not going to -- they're not going to -- that's not their new normal. I don't know where it goes, if it goes to 80% or something, it's just a matter of when at this point.

Got it. Switching gears from volume to pricing. In the second quarter, you pointed out a deceleration in the TRASM environment. Was that a little sooner and a little more severe than you expected, kind of? In particular, I kind of thought that TRASM would hold out a lot more, given some of the kind of ongoing constraints on capacity, especially over the summer. So again, is that largely a function of international versus domestic? Or kind of how do you see that evolving?

Yes. I mean, our best hypothesis is that was the biggest driver. It was a point or 2. I think we talked about this on the call a bit of missing demand that went international that would have been competing for the seats that we were selling. We flew very full. And when you're flying at 88%, 90%, you're probably spilling traffic. So there may have been more a lot of opportunity, and that's something like our RM team is going to look at. I think that it was modestly lower the revenue forecast than we would have guessed at a few weeks prior. And I think the only thing that we saw that was really different was disproportionate shift to international. And then the whole commentary over the Q2 cycle was, is that structural now? How long is it going to persist? Domestics are out of favor, all that sort of stuff. And we sort of thought people will go to Europe like now and probably not again in the fall or in the winter. And a lot of people go to Europe. They don't go to Europe every year. It's not going to be 2 of their 4 trips a year, right? So we do think it's going to normalize. Like I said, there's nothing in the Q4 data that suggests we're not going to have a relatively balanced domestic demand environment relative to international.

But is that balance that helps the TRASM sequentially as well?

I think it's -- yes, it does give us more support on the unit revenue side for sure.

Got it. .

All else being equal, there's a lot of -- like it depends on where we end up with capacity versus demand as well. But yes, it's getting more of the demand back into the domestic market is going to be helpful for us.

Well, the other thing that kind of went differently than we expected was jet fuel went a lot lower than we thought. So do you think that had anything to do with it? And like is it $3-plus jet fuel environment actually good for TRASM?

Yes. Yes, that was all well-timed, like 1 week after we reported. I think the refining margin went through the roof and then it settled down.

The [indiscernible] are waiting for you guys before.

Yes, exactly. There were spot prices through the roof. Look, it's I -- look, we are as sensitive to the volatility of -- looking at our own forecast and seeing 1 input change our margin outcome by 200 or 300 basis points is frustrating. We typically plan for $3 fuel in almost any environment. If it's $2.70, we plan for $3. If its $3.25, we plan for $3. I think, on average, we're right. In any given period, we're wrong. But I do think that the higher it is, the more advantage we have. We have a young fleet. We've got a fuel-efficient fleet. We've got lots of MAX aircraft with a LEAP-1B. So proportionately, we have a really good set up. And I do think that there's almost always some correlation between price of fuel and long-dated capacity decisions. Close-in, it never changes. We're already staffed for our close-in plan, You're not going to park all those planes. But as you think about how to plan for next spring, if people are planning for $3.25 fuel, I think you come up with a different network than if it's $2.75. That's my general belief, and I think it will probably hold true again.

Got it. We've spoken a couple of times on your conference calls about the potential for a permanent mix shift between international and corporate and how you maybe adjust for some of the RASM shift there? What's your latest thinking on that? And kind of do you think some of that goes into 2024?

The leisure...

Leisure versus corporate, yes. It's going to be that corporate customer never comes back on the tech side, in particular. Kind of how do you put the leisure travel in front of [ lens ]?

Yes. I think even before this sort of period, as we reshape the network coming out of COVID, we were reshaping more towards leisure-oriented markets. So we're flying more California into Florida, more Seattle into Florida. We just announced Nassau, doing a lot more into Latin. We're, I think, one of the largest carriers from the U.S. into Mexico today. And I think you'll see us continue to do that. Those tend to be really our sweet spot, a 5- to 6-hour flight is perfect for our product. We tend to get like the right yield. We've got really efficient cost performance. You can fly down and back with a plane and rest it overnight. It's like a really good utilization play. And I think you'll see us do more of that. Our core business markets, we still have lots of frequency in. And so if the business demand comes back, they're going to have lots of choice. We fly over 10 times a day up and down the West Coast, so the key sort of business markets we serve. Lots of frequency out of Seattle to the East Coast, Bostons, New Yorks of the world. So if we see it come back in a step change, we might be a little behind the power curve, but it seeps in little by little. I think, schedule by schedule, we can adjust more of the capacity of the business market. But right now, yes, I think we've always been more leisure-focused, probably 65-35 is the split today. And I think it's working well for us, and it's what we anticipate the mix going forward will be, give or take.

Is bleisure still happening? Or was that also a COVID-only thing?

I don't -- I haven't seen the bleisure report, yes.

Are we saying that word anymore?

I just -- I'd say, I'm looking for it from the team, like I don't know. I think, for sure, anecdotally, people were mixing trips, and they were going on a 2-day business trip and spending a long weekend somewhere, there's no doubt.

Their family's here.

Yes, yes, yes. And I don't -- I think it's still happening. I think even with everything, there's like a bell curve to it, we've probably peaked and it's coming down a little bit to normalize. But I'll tell you, like there are companies, I won't name them, that have told us their travel management departments are actually trying to think of how to make business trips more value-based for the traveler, get more work done and also like have an opportunity to extend it into like some sort of like 1 day of pleasure or something like that. But that's like a thing on their minds. So maybe it's going to be persistent. Maybe...

Conferences in nice places are a good start.

Right. Right. Yes, especially in Laguna, although, I'd tell you, I flew in and I went for a walk because why wouldn't you in California? And it rained last night. I was like I could do this in Seattle, Ravi, like it's certainly sunny, but okay.

Man, that's some bad luck. Maybe shifting gears here on the cost side. Obviously, inflation has been top of mind for investors, and obviously, the labor side, training costs and everything else. A, when do those costs start to lap? When do they start to even subside, if you will? And kind of is there a path to lower CASMex that does not involve significant expansion of the fleet?

Got it. Really key question. I think the sort of biggest spike is behind us. A lot of that has been pay rates, both labor that we employ directly and third-party suppliers as well. There's still some more to do. We just announced a tentative agreement with our mechanics this week. We still have to get a deal with our flight attendants. Those are both critically important. But I think most of that is behind now. And you'll start to see full lapping of that next year. I think the rest of the cost structure is in decent shape. A lot of the costs that we have are essentially fixed. Like a lot of our maintenance costs are under long-term contracts with fixed rates. The area that like is probably the biggest headwind for us is airport-related costs. There's a huge CapEx sort of cycle going on in the West Coast and a lot of the airports we are large operators out of Seattle, Portland and others, those are -- they're tough because they are big step changes in the P&L, but then they don't move for 25 years after that. And so you just got to sort of get through it. And we've got a couple more years of airport cost headwinds. Having said that, to answer your question, I think if we could grow a modest amount next year in the middle-ish of our sort of long-term target range. We have a good shot at seeing unit costs flat to down. Not predicting that. We haven't gone through the budget cycle. I do think we're relatively in a good spot relative to competitors. Like we're very conscious of our cost structure and what it looks like post-COVID versus the rest of the competitors in the industry. We've lost no ground, and I think we're in a position to be able to gain some ground over the coming year or 2. We've got, with the single fleet, a lot of opportunity for more efficiency, productivity. And we're sort of excited to see if we can get 1 or 2 points, even more competitive on a cost basis versus the industry. I think we're well below the legacies. I think our unit costs are below JetBlue, and they're as close to Southwest as we've ever seen since I've been at the company. So while the industry has structurally increased, I think we're doing a relatively decent job. You guys know our full year guide. You know the first 2 quarters actual, the updated guide for Q3, you could impute Q4, I'm sure you have. I think it's a good exit rate, if we hit it. So I think we're in a decent spot.

Yes. Got it. Just kind of extrapolating that topic. Look, there's a lot of focus on demand right now, the demand environment, but no one's focused on demand in isolation. So always demand versus supply, right? And that's where there's a lot of concern that, on the domestic side, you're seeing a bunch of new capacity come in from the regional carriers, low-cost carriers, ultra-low-cost carriers. How concerned are you? And kind of do you think that this industry kind of is getting to a point where it's not learning from past mistakes and it's obviously never you, it's always the other guy?

Yes. That's right, yes. Of course, yes.

Right? So are you concerned about capacity growth going to '24?

Look, yes, let me answer it this way. If everybody's current sort of number they're talking about in terms of 2024 growth happens and there isn't an upturn in the economy, I think that's a tough setup, right? I think all of us -- like the math is pretty simple. It's going to be a tough setup. I think a couple of questions to ask or -- is that capacity going to materialize? And most of the revisions, material revisions, capacity guides over the last 2 years have been down, right? And at some point, that won't be the case, but I sort of have -- I anticipate that, that may continue to be the case, generally speaking, especially if high fuel persists. I don't personally think like it is a cyclical business. You can't do everything for the next quarter. But I don't think most management teams are going to stare at budgets that say, "I'm going to go have 200 or 300 basis points of margin go away." Like, I think, once you see it is when you start to say, "Okay, I got to rethink. Where am I deploying capacity " How am I deploying it? And I think management teams do want to have good businesses. I think they want to repair balance sheets. And I do think there's real constraints on the supply of aircraft still. And so my sense is we'll probably see a little less capacity than people are talking about. If we don't, and if the economy struggles or it's sort of flat lines here, that's going to be a tougher setup from a pricing perspective. I do think the one thing, I'd say, Ravi, about us, we have like potentially unique drivers of revenue, top line versus a lot of the rest of the industry. We're doing things now that the industry has had done 5 or 10 years ago. An example would be the amount of First Class we're selling. Pre-COVID, we were selling 40%. We're selling sub-60 today, but up from 40%. A lot of our competitors sell 80% of that cabin. I don't think we'll ever go that far. We want to keep a lot of upgrades in the system for Elites, but we could go sell a little bit more of that and probably will. And that is an opportunity for us to relatively outperform on the revenue side if it's a more challenging environment.

So do you think your peer -- I'm not asking you to answer for your peers, obviously, but kind of as an industry observer, do you think it's a little bit of hope and faith, but you are confident that when it comes time to actually deploying the capacity, they will show the discipline and say, "Hey, the demand is just not there." Or I mean, if you don't have a plane, it's not much you can do, but...

Right, right, right.

Do you think this industry will still do the right thing? Or do you think it...

Look, I understand the question. I think you could look at a lot of cycles in the industry and come to a conclusion that we -- like we all are going to do the capacity thing, managing the cost down and then wait until results really get materially worse before we change. I like to think that we're not going to go back to behaving that way as an industry. If you look at the period of '09 to '19, our worst margin, I think, was 9%. And there was a lot of years of massive capacity growth, if you recall, in Seattle, us and a competitor. And I don't know, over a 10-year cycle with like huge competitive capacity buildup in our key city of markets, both us and that competitor were able to do relatively well. You could argue it could have been better? Yes, but we weren't languishing in low single-digit margins or approaching 0. So I tend to have a little more confidence that we're all not going to race ourselves down to the bottom here. But I get the question, and I think it's a salient one. And some of these proposed growth rates are high.

Yes, yes.

And I get it -- like if the industry thinks that it can grow capacity 2x the economy grow -- the economic growth, like that's a tough setup.

I mean a lot more of that travel and leisure to come.

Right, right. Yes, yes, yes.

Any questions in the audience? One back there.

Can you hear me?

Yes.

I was just wondering if you could give an update on some of your alliances like oneworld. You kind of talked about international as well. So if you're seeing upside with the international travel through these alliances and maybe how you kind of measure performance metrics and kind of success in those alliances?

Great. Yes. Thanks. So 2 -- just to remind everybody, like 2 big things that we did during COVID. We got into an alliance partnership with American and renewed one, it's called the West Coast International Alliance. It's very much focused on us helping to feed their international complex off the West Coast. I think the relationship is doing phenomenally well. They're a great partner. We just turned on a bunch of additional code domestically beyond a number of cities. I hope they feel the same way. I think they're getting a lot of value out of the partnership. I know we are. And I think it's a really attractive loyalty proposition to both their core guests and ours as well, and a growing number of guests in some of the markets where we've been more growth-oriented like California. And then the other was joining oneworld. That was all about giving our loyal guests an opportunity to fly anywhere they wanted in the world, out of Seattle and off gateway cities in the West Coast. You've seen oneworld partners increase service into the West Coast cities, and I think you'll continue to see that. We're now selling 9 of our partners. I know it seems easy you should just be able to sell everybody. It's really hard in this industry. So not only do you have to partner, you've got to go and actually sell their tickets and service their tickets. We're now doing that with 9 partners. We'll have a 10th up before the end of the year. And then we're going to start selling Premium Cabin. So we're just selling Main Cabin right now. So then we'll start selling Premium, which is a bit -- that's where a lot of the value ultimately accrues. I'd say, on the oneworld side, most of the value really should -- revenue value should accrue to our partner. We're filling their planes, sometimes not even with a connecting leg on us. It's just a local ticket from Seattle to Doha or something like that. But the value to us is keeping that person on our loyalty program. They keep our credit card. They swipe it more. They're not our competitors. And you don't see that in the period -- in the P&L where they fly, but you get that impact and effect over time. I think we'll be able to measure that more in the next year or 2 as we actually start to see international now having opened up and how much traffic we're placing on our partners. We'll be able to measure the stickiness and the additional loyalty we're getting. It's too early to do that. It's just started, but we'll be able to do that soon. And then I think on the alliance with American domestically, you really want to see when we're selling each other's traffic that those yields are coming in at system average or better. And they are right now, and you want to continue to see that. Because if they're not, then there's like this argument, "Could I have sold that ticket myself or something that with that system average." And right now, they're really high-quality tickets. And there's other ways we measure it. Those are the 2 that we'll probably talk about more over time. But really good initial start to both of these now that international is open back up, and there's a lot of demand, just generally to travel right now, and I think it's all upside from here.

You talked a little bit about the concerns around general industry capacity and why that may or may not play out next year. The news we got yesterday on the GTF positioned you particularly well not having that exposure in your fleet. Have you thought about or quantified the impact that's going to have next year on general industry capacity growth?

Great question. No, not yet. We weren't anticipating the news that came out. So it's all pretty fresh. I think certainly, our friends down in Hawaii are impacted by this. And then I think most of the impact is East Coast-oriented, JetBlue and Spirit. And by the way, I like -- being in airline management, I don't wish this on anybody. Airlines work incredibly hard to go build their networks and hire people and make these business models work and to have this like nobody -- somebody's fault. Like the engine manufacturers do the best they can, too, but like to have like 25% of my fleet that may have to go in early, it's just really hard on those companies and those employees. And I'd wish they were in a different position. We haven't figured out what the net impact is. Maybe it's more outside of our network anyhow, but haven't really done any analysis on it.

Any other questions? So maybe just to kind of wind up kind of how are we thinking in terms of just incremental growth opportunities? Obviously, at the Investor Day, you had, I think, 4 different kind of new revenue opportunities. Kind of, how is that tracking? And kind of when do you think you can line up and reload that pipeline, if you will, for more ideas and credit growth to come?

Yes. Great question. I'm not going to -- I won't preview our next Investor Day too much. We got to decide when we're going to have one. I think the loyalty side is pretty much done. A lot of that was the new bank deal. We've seen amazing growth on the credit card penetration side, and we've seen spend hold up really well. I know like -- I think our trends are similar to others. And so I don't know if we're ahead or not, but we're doing really well from that perspective. We're just getting going, I think, with merchandising. We are now starting to do in-path upsells that we weren't doing before, post-sell upsells that we weren't doing before, into Premium Economy and the First Class and really good early returns. We started to selectively sell some exit row capacity, being very mindful of making sure our leads have access to those seats on the aircraft. And I think you'll continue to see us work on merchandising seat products. And we haven't talked a ton about those, but I think there's a good chunk of opportunity there. Look, the alliance stuff we just talked about, I won't go through it again. Whenever we do another Investor Day, we'll be more deliberate about quantifying and improving some of the value that we see in the P&L from that. And we've got our commercial team working hard. They know like structurally costs are up, structurally revenue has to be up. And so whether it's the amount of each cabin we sell versus upgrade or we look at new revenue streams, we've got them hard at work, building a plan for next year that we think will help us outperform whatever the underlying general pricing environment is. But we're not ready to quantify that yet or talk too much about it.

It sounds good. We'll wait for the next event.

Yes, yes.

Shane, thanks a lot for being here. I know it's logistically a bit of a challenge, but I'm glad you made it work.

Yes, me too. Great. Great to see you. Thanks, Ravi.

Thanks, Shane.