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Alaska Air Faces Rating Downgrade as it Enters a Turbulent Market (NYSE:ALK)

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Alaska Air soars above turbulent times, embracing challenges head-on to maintain its position as a reliable and resilient player in the aviation industry.

In April 2023, I marked Alaska Air Group (NYSE:ALK) stock as a buy based on its 2023 projections. However, since then, the stock has lost more than a quarter of its value due to various factors impacting the airline industry, particularly Alaska Airlines. In this report, I will discuss the most recent results and use a combination of fundamentals and forward projections to determine the price target and adjust my rating for the stock if necessary.

For the third quarter, analysts expected revenues of $2.87 billion and core earnings per share of $1.87. However, Alaska Airlines missed estimates with revenues of $2.84 billion and core earnings of $1.83. Revenues remained stable year-over-year, despite a 14% increase in capacity. This suggests lower unit revenues and yields. The company experienced a $20 million reduction in revenues as leisure travel did not extend as deeply in September as expected, and corporate travel remained stagnant at 85% of 2019 levels. This resulted in pressure on load factor and lower revenue generation on higher capacity.

Total costs declined by 5%, which is refreshing compared to other airlines experiencing rising costs. Excluding special items, costs would be 2% lower. Reported fuel expenses dropped by 21% and included positive adjustments of $35 million this year compared to a negative adjustment of $131 million last year. Incorporating this, operating expenses would be 5% higher.

Unit revenues dropped 12% and yield dropped 10%, while CASM-ex dropped by 5%. This demonstrates good adjusted cost control but disappointing revenues due to deploying capacity in markets that underperformed and insufficient business travel carrying Q3 demand.

Looking ahead, Alaska Airlines expects fourth-quarter revenues to be up 1 to 4 percent, driven by higher fuel prices. The adjusted profit margin is predicted to be slim at 0 to 2 percent. For the full year, the company anticipates capacity to be up 12 to 13 percent, narrowing the previous range of 11 to 13 percent. Revenues are guided to increase by 7 to 8 percent compared to the previous estimate of 8 to 10 percent, indicating a change in market dynamics including weaker close-in bookings. Adjusted margins will be 7 to 8 percent, adjusted downward from 9 to 12 percent due to higher fuel prices and weaker unit revenues. Earnings per share are now expected to fall short in the range of $4.25 to $4.75, compared to the previous range of $5.50 to $7.50.

Alaska Airlines is facing specific pressures, such as its Maui operations representing 4% of its capacity. Although bookings have recovered somewhat, they are still down 45%, resulting in an expected revenue pressure of $18 million. Additionally, higher fuel prices in the West are creating a headwind. The disparity between Gulf Coast and West refining margins caused a $50 million increase in fuel costs, impacting near-term earnings. The company is also negotiating new labor agreements with cabin crews and mechanics, which will likely lead to further labor cost increases.

While there are uncertainties in the airline industry and unwanted certainties like higher fuel prices, analyzing the balance sheet data and forward projections still show upside for Alaska Airlines. However, the upside is more skewed towards the mid-decade, and the projections for 2024 include some pressures. As a result, I rate the stock as a hold, noting that there is a discount compared to 2024 earnings, but it is unlikely to offer an attractive risk-reward. Alaska Airlines is facing challenging times ahead, with higher refinery margins in the West, increased labor costs, and misplaced capacity counting on similar booking patterns observed last year.

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