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The big divide between airlines & Wall Street: PRASM

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How much does PRASM mean?

There was a fascinating exchange towards the end of Alaska Air Group’s second-quarter earnings conference call with analysts that perfectly encapsulated the big divide between US airline executives and Wall Street. That divide is over PRASM and how much it means. While US airlines are consistently generating strong bottom-line net profits, they are also reporting year-over-year unit revenue declines quarter after quarter.

This drives Wall Street nuts. If things are so great for airlines, investors want to know, why can’t you achieve positive PRASM growth? Airline executives say they care about PRASM—and are making capacity adjustments to improve PRASM performance—but they encourage investors to focus more on bottom-line net profit results and what they believe is the long-term sustainability of US airline profits. PRASM, US airline executives generally argue, is a short-term metric.

But the sluggish PRASM performance is what is keeping US airline stock prices frustratingly low—this drives US airline executives nuts.

That’s the context under which Wolfe Research’s senior analyst covering airlines, Hunter Keay, came on to Alaska’s second-quarter earnings call to say he was “a little frustrated” by airline executives “talking about PRASM as some sort of short-term only metric” that hedge fund managers care about and “long-only guys [i.e. airline executives] dont care about.” Keay insisted that interpretation is “just not true” and that airlines’ PRASM struggles are “not sustainable.”

Brandon Pedersen, Alaska’s CFO, heard Keay use the word “frustrated” and apparently misunderstood Keay as saying he’s frustrated that there’s too much focus on PRASM by the investment community.

“Yeah, Hunter,” Pedersen said. “I agree with you. I don’t know why there is so much focus on PRASM. What I would do if I were an investor is I would focus on profit, and I think as you think about our business going forward either as Alaska standalone or as a combined company [with Virgin America], we are going to make profit-maximizing decisions and some of that is going to come from PRASM and some of that is going to come from CASM. I think the danger of focusing just on PRASM is that you don’t know what happens in any particular market. You don’t know what happens with fuel prices and I think you are seeing a lot of that now. But at the end of the day, its really [maximizing profits] that matters and profit on the bottom line and actual cash that goes into your checking account that you can use to deliver the balance sheet and pay back debt and return capital to shareholders. So I agree with you. I...”

At that point Keay cut Pedersen off. “Brandon, Brandon,” he said. “I am sorry to interrupt you, but I think you misheard me. I am saying the exact opposite, to be clear. I think PRASM matters a lot because it’s a proxy for pricing power.”

Alaska chairman and CEO Brad Tilden then quickly jumped in to assure Keay that he was “making a great point.” The problem, Tilden posited, is that airlines don’t express their unit revenue goals clearly enough.

“I think youre giving us and other management teams a great challenge,” Tilden told Keay, saying airlines should develop a “longer-term message to say what are you going to do for the revenue side of the business … I personally think you have given us a good challenge and we should take that away and think about it. We might come away a stronger airline if we had a way of articulating our [unit revenue] objective.”

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