On-time performance dips as Alaska Air integrates Virgin
Alaska Air Group Inc.’s financials are still very strong after turning a $296 million profit in the second quarter, but company executives acknowledge uncharacteristic operational challenges have beset the airline company as it continues to integrate Virgin America into its formerly stellar business.
“To be direct, our operational performance has not met our expectation in the first half of the year, but we’re on the road to recovery now,” said Brad Tilden, CEO of the Seattle-based parent company to Alaska Airlines, regional carrier Horizon Air and of-late Virgin America.
Tilden made his comments during a July 26 conference call with Alaska Air Group investors about the quarterly earnings report.
“Despite starting the year in the back of the entire pack, our team has rallied and we’re now in the No. 2 spot in on-time performance among the six largest airlines in the United States,” he said further. “I’m proud of our team, but we have more work to do.”
Alaska Airlines has long overcome operating in one of the harshest weather states to be one of the top performing major domestic carriers and has many industry awards to prove it.
In 2016, more than 87 percent of the airline’s flights arrived on time, making it the best large carrier in terms of on-time performance for the seventh consecutive year, an accolade the airline has understandably touted.
However, this year things have slipped. Through June, 80.5 percent of Alaska’s flights this year had arrived on time, down from 88.1 percent through the first six months of 2016, comparatively.
The decline in the primary operational metric performance has been even more precipitous for Virgin America since officially being taken over by Alaska Air Group last December. Virgin America’s on-time performance is off 12.2 percent for the first half of 2017; just 64 percent of its flights have been on time this year.
It should also be noted — as Tilden alluded — that the airlines’ performance is improving.
Nearly 83 percent of Alaska’s flights pulled up to a gate when they were supposed to in June and more than 67 percent of Virgin’s flights did the same.
The trends are similar for Horizon Air’s flights. Horizon operates flights for Alaska Airlines between Anchorage, Fairbanks and Kodiak.
Company executives did not offer many specifics as to why so many more flights have been late, but Tilden attributed part of the problem to increasing nationwide airport congestion, saying it has been particularly bad in Seattle, San Francisco and Los Angeles, which are primary Alaska and Virgin America hubs.
“Our team is working on a playbook that will standardize across the various parts of our operation and our customer communications organizations how we handle — or how we’re going to handle — typical ground delay programs and irregular operations.
In spite of the on-time struggles, Tilden noted that the company’s in-house customer satisfaction rating for the quarter was very near an all-time high; Alaska Airlines earned its 10th consecutive J.D. Power quarterly customer service award; and Virgin America was again rated as the best domestic airline by Travel+Leisure for the 10th year running.
As for the finances, Tilden said about $30 million of the $296 million profit was attributable to Virgin, meaning Alaska’s and Horizon’s business roughly matched the $263 million record profit Air Group turned in the second quarter of 2016 before acquiring Virgin America.
The profit, which translated to $2.38 per share of Air Group stock, was on the back of $2.1 billion in revenue.
The company paid a dividend of 30 cents per share during the quarter, up from 27.5 cents per share in 2016.
Alaska Air Group stock closed trading on the New York Stock Exchange July 28 at $86.32 per share, down slightly from its pre-earnings report price of $87.13 to close July 25.
Air Group also blended its 2016 financials with Virgin America’s equivalent pre-merger results in an attempt to provide at least a rough comparison of how the 2017 figures compare year-over-year, understanding the numbers to not account for post-merger operational or managerial changes.
Based on those results, the $2.1 billion in quarterly revenue is a 10 percent increase from 2016 and the $3.8 billion in revenue year-to-date reflects 6 percent growth.
Without including Virgin America’s 2016 financials in the comparison, Alaska Air Group’s revenue is up about 40 percent year-over-year.
Total assets grew to $10.7 billion at the end of the quarter. It started 2017 with $9.9 billion in assets.
The company generated $1.1 billion in operating cash flow, $512 million of which was committed to capital projects, leaving $572 million in free cash flow during the quarter.
Alaska Air Group held $1.9 billion in cash and marketable investments at the end of June.
Fuel, often an airlines largest expense, was up 11.8 percent on a per gallon basis for the quarter to $1.71 per gallon. For the year, Air Group, which hedges on fuel, is paying 24 percent more per gallon at an average of $1.75, compared with $1.41 per gallon in 2016.
After adding Virgin America’s fleet of nearly 70 Dutch Airbus aircraft, fuel efficiency has also slipped by 2.3 percent on a capacity-flown versus gallons burned basis in 2017. Fuel efficiency is a metric Air Group has consistently improved in recent years and company leaders have used to support the purchase of many new Boeing 737s — the only aircraft Alaska Airlines flies.
Fuel efficiency was down 3.1 percent for the quarter year-over-year.
“Generally speaking, I would characterize our cost performance as needs improvement,” Air Group Chief Financial Officer Brandon Pedersen said during the earnings call. “It’s clear that the operational challenges and integration complexities have been driving some cost creep, but we’re also not at peak performance applying the tight cost management practices that we’ve relied on for many years now.”
On a positive note, the company’s debt-to-capitalization ratio was down to 55 percent at the end of the quarter after starting the year at 59 percent.
Air Group’s debt-to-cap was 25 percent a year ago before closing on Virgin America Pedersen said he expects to get to the 51 percent to 52 percent debt-to-cap range by year’s end.
Ultimately, he has said the company hopes to return to the 40 percent debt-to-cap range.
Company executives have long stressed a desire to be a strong industrial-style company with an investment-grade balance sheet despite being in a highly volatile industry with a history of airlines that overextend their debt leverage.
Looking ahead, Tilden said he expects to enter arbitration with Alaska pilots in August with a decision likely sometime in October.
To that, Pedersen said the company’s proposal would increase pilot costs by $140 million per year and equate to a 3 percent increase to consolidated costs outside of fuel.
“It will reduce our pretax margin by more than 1.5 points. And it will, by far, be the biggest increase ever for Air Group from a new labor agreement,” Pedersen said.
The company agreed to an amended contract with Horizon pilots earlier this year after the pilots’ union alleged Horizon had offered new pilots hiring bonuses outside of its contract terms.
On integrating Virgin America into Alaska Airlines, Tilden said he expects to have a single customer loyalty program, one HR and payroll system and a single financial system by the end of the year. A single operating certificate from the FAA is expected by the end of the first quarter next year, he added.
Finally, Pedersen said a decision has not been made as to whether Alaska Airlines will continue with its all-Boeing fleet once the airlines are fully blended.
“While we recognize there’s a great deal of interest in this question, it’s not urgent that we decide as the Airbus leases don’t even start to expire until 2019,” he said.
To that end, Tilden has said Air Group has a very strong relationship with Boeing, a fellow Seattle company, that it wants to retain.