In Flight with Alaska Air

04/24/2017 2:50 am EST

Focus: GLOBAL

Richard Moroney

Editor, Dow Theory Forecasts

Don’t read too much into the name of Alaska Air Group (ALK) — there’s a lot more to the company than flights to and from Alaska, states Richard Moroney, editor of Dow Theory Forecasts.

In the wake of December’s purchase of Virgin America, Alaska Air has become the largest airline on the West Coast, with 286 planes flying more than 1,200 routes a day, reaching about 900 destinations.

Expectations for the combined company are rising, with the per-share-profit consensus for this year up 19% over the last three months, while the 2018 consensus has risen 14%.

Despite the higher targets, growth expectations remain reasonable, with analysts projecting profit growth of 9% in both 2017 and 2018. Alaska Air, yielding 1.3%, is a Buy and a Long-Term Buy.

Alaska, which purchased Virgin America for $2.6 billion last year, plans to drop the trendy brand by 2019. Not surprisingly, Virgin founder Richard Branson panned the move.

But Alaska plans to retain many of the features that made Virgin America so popular and hip — including mood lighting and a wide selection of in-flight entertainment options.

The merger is not without its problems — including concerns about the need to maintain two types of aircraft, Boeing (BA) jets for Alaska’s legacy business and Virgin’s Airbus planes.

However, Alaska has announced plans to retrofit many of the Airbus jets to accommodate more first-class and extra-legroom seats, bringing them closer to the model of Alaska’s own planes.

In addition, the company is working with employees to preserve elements of both the Virgin and Alaska business cultures, in hopes of blending the best of both. Remember that even before it purchased Virgin, Alaska stood out from the pack because of its service:

* Nine straight years with the highest customer satisfaction among traditional North American carriers. 
* Best in on-time performance in each of the last six years.
* No. 1 in The Wall Street Journal’s “Middle Seat” scorecard for airlines in four consecutive years.

While Alaska uses a different playbook than Virgin America, both focus on service. This commonality of approach gives us confidence that Alaska can handle an admittedly complicated merger. Last year, Alaska grew its capacity 10.3%, while traffic rose 13.1%.

Capacity growth is expected to slow this year (excluding merger effects), as Alaska, along with many other air- lines, cuts back on its investment in new routes. In February, capacity rose just 1.2% while traffic increased 1.7%, causing the load factor, a key measurement of airline efficiency, to increase.

Airlines as a group face several challenges, including rising costs for labor. However, Alaska boasts the best cost structure in the industry, giving it more flexibility for dealing with higher expenses.

The airline delivered an operating profit margin of 30.8% last year, best among the eight largest U.S. airlines and well above the industry average of 23.1%.

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