Late last year, Alaska Air (NYSE: ALK) seemed to be bouncing back from a slump that caused its adjusted pre-tax margin to plunge from around 24% in 2015 and 2016 to 8.9% in 2018. Back in January, the company forecast further progress in the first quarter of 2019.
However, Alaska Airlines, like several of its peers, slashed its Q1 guidance last month. Fortunately, Alaska's management was overly conservative in its early March guidance update. Last week, the airline improved its forecast for the first quarter. Furthermore, it noted a bounce in demand beginning in mid-March, which bodes well for the second quarter and beyond.
Solid guidance comes down -- and then rebounds
During the fourth quarter of 2018, Alaska Airlines' revenue per available seat mile (RASM) rose 5.2%, a sharp turnaround from the first half of the year, when RASM was still plunging. Alaska's initial guidance for the first quarter pointed to relatively steady trends, calling for 2.5% to 4.5% RASM growth. That would have been enough to drive modest margin expansion, based on management's forecast that nonfuel unit costs would rise 4.5% to 5% year over year, partially offset by a modest decline in the carrier's average fuel price.
By early March, the outlook had changed dramatically. At that point, management projected that RASM would increase just 1% to 2% for the first quarter, because of weak pricing for last-minute tickets on transcontinental flights, as well as the impact of severe winter storms in the Pacific Northwest, particularly in Alaska Airlines' hometown of Seattle.
A little over a week later, Alaska provided another update. The company increased its fuel price estimate for the quarter from $2.05 per gallon to $2.14 because of a surge in oil prices during the quarter. On the other hand, the carrier reduced its nonfuel unit cost growth guidance to a range of 4% to 4.5%.
Last Thursday, Alaska Airlines published its final investor update for the first quarter. RASM rose 2.1% year over year for the quarter, modestly exceeding the high end of the carrier's March guidance range. Management said most of the outperformance was driven by a rebound in pricing for last-minute tickets on transcontinental flights to and from California.
Alaska also lowered its estimate of nonfuel unit cost growth for the quarter to 3%, because of good cost control and a shift in the timing of certain expenses. Based on the updated outlook, Alaska's Q1 adjusted earnings per share will likely be roughly in line with its Q1 2018 result of $0.14.
Strong profit growth should resume in Q2
Better pricing for last-minute tickets on transcontinental flights in the second half of March bodes well for demand heading into the seasonally stronger second and third quarters. But that's just one reason for investors to be optimistic about the current quarter.
The timing of Easter also dampened RASM growth by more than 1 percentage point last quarter but will have a roughly comparable positive impact on RASM in the second quarter. The winter storms and federal government shutdown that hurt unit revenue last quarter won't have any further impact. Finally, Alaska expects to get a bigger benefit from merger synergies and other recent revenue-enhancing initiatives this quarter than it did in the first quarter.
As a result, Alaska Airlines' RASM growth is likely to accelerate this quarter, returning to mid-single digit territory -- if not better. That would likely drive a double-digit EPS gain.
More good things ahead
Looking beyond the second quarter, year-over-year revenue comparisons will start to become tougher. But Alaska Airlines expects its merger synergies to continue building through 2021. It also has an opportunity to upgrade a big portion of its fleet over the next seven years or so, driving substantial cost savings.
Management has set a medium-term target of achieving a pre-tax margin between 13% and 15%. Alaska Air still has some work to do to reach this goal, but it seems achievable in light of the carrier's previous track record and its ongoing profit growth initiatives.
At the midpoint of this range, adjusted EPS could reach approximately $8.00 next year. With Alaska Air stock trading at just 7.5 times that level and EPS growth set to accelerate in the coming quarter, it could be a great time to invest in this promising turnaround candidate.
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Adam Levine-Weinberg owns shares of Alaska Air Group. The Motley Fool recommends Alaska Air Group. The Motley Fool has a disclosure policy.
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