Alaska's profits predicted to soar in spite of headaches

Alaska Airlines' decision to outsource its ground operations at Seattle-Tacoma International Airport has caused a lot of headaches, including lost bags, delayed flights and two high-profile mishaps in which planes were damaged.

Yet that same decision helps explain why Alaska is expected to be one of the few U.S. airlines to post a profit for 2005 when it reports its annual results Thursday.

Through a combination of outsourcing, layoffs and strategic fuel purchases, Alaska has reduced its costs by up to 25 percent in recent years. At the same time, the airline has steadily expanded its customer base; it carried 23.2 million passengers last year — up 4.6 percent from 2004 — even though many of its cost-cutting moves upset some longtime customers.

Alaska is expected to report a profit of $46 million for 2005, or $1.66 per share, according to analysts surveyed by Zack's Investment Research. That would be a substantial turnaround from a loss of $15.3 million in 2004.

Longtime Alaska customer D.J. Baker exemplifies Alaska's situation. He says more than $1,000 of camera equipment was missing from his checked baggage after a flight from Las Vegas to Seattle earlier this month.

"If I have a choice on any future flights, I will try to take another airline," said Baker, a creative director for Cutter and Buck. And yet today, Baker is flying to Orlando — on Alaska Airlines.

Why? "It's the only direct, nonstop."

Analysts say that despite those passengers who do get upset, airlines stand to gain by hiring outside contractors for some operations.

Outsourcing "is the name of the game in the airline business," said Michael Boyd, president of the Boyd Group, an aviation consulting firm in Evergreen, Colo. "There's a lot of things that airlines have found can be done more efficiently outside the company."

The strategy didn't look so smart on Dec. 26, when a hole ripped open in the fuselage of an Alaska jet at 26,000 feet after a ramp worker had hit the plane with a baggage loader. The worker, employed by contract baggage handler Menzies Aviation, had not reported the accident, which happened shortly before takeoff.

Video taken inside the plane after the cabin lost pressure ended up on ABC's "Good Morning America," and a passenger called the incident "horrifying" in an Internet blog that received national attention.

Yet the plane landed safely, and no one was injured or killed.

Consequently, Boyd said, "[Such incidents] fade away quickly in people's minds. You had a ramp worker that didn't do his job properly. That was a one-off event."

Alaska has had subsequent problems with Menzies, including a Jan. 5 accident in which a worker inadvertently tugged a 737 into a jetway and baggage loader, damaging the plane.

But Betsy Snyder, who monitors U.S. airlines as a credit analyst for Standard & Poor's in New York, said that after the flight with the torn fuselage, the ongoing issue "hasn't gotten that much press outside of your area."

"People know it is still the hometown airline that people like to fly on," Snyder said.

Among major U.S. airlines, Standard & Poor's assigns Alaska a very strong credit rating, second only to Southwest Airlines.

"They had a good third quarter and they've done well because of their fuel hedging," Snyder said.

Unlike many U.S. carriers, Alaska and Southwest locked in fuel contracts before oil prices soared in the summer and fall due to instability in Iraq and supply problems after Hurricane Katrina.

Bob Toomey, chief equity strategist for E.K. Riley Advisors, recently trumpeted Alaska as a "contrarian value investment" because it is performing much better, financially, than most of its U.S. peers.

"Alaska Airlines has reduced its operating costs considerably over the past several years — we estimate by as much as 20 percent to 25 percent ... as a result of management's cost reduction programs," Toomey wrote in a recent research report.

Toomey expects Alaska's stock to hit $45 to $50 per share within two years; it closed Tuesday at $31.38.

Ray Neidl, an analyst with Calyon Securities in New York, on Dec. 22 raised his price target for Alaska from $35 to $40 per share.

Like Toomey and Snyder, Neidl praised Alaska's outsourcing and its fuel-hedging strategy, as well as its ability to protect and enhance its position as the dominant carrier on many regional routes.

"They know how to service their ... area up and down the West Coast and into Alaska," Neidl said.

And, despite recent events, "They've got a good reputation as a well-run airline," Neidl added. "People like to fly them, especially when your choice is between Alaska and Southwest."

David Bowermaster: 206-464-2724 or dbowermaster@seattletimes.com