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Alaska Air Group, Inc. (NYSE:ALK)

Investor Update Conference

July 11, 2013 10:30 am ET

Executives

Chris Berry - Managing Director of Investor Relations

Bradley D. Tilden - Chief Executive Officer, President, Director , Chairman of Management Executive Committee, President of Alaska Airlines, Chief Executive Officer of Horizon Air and Chief Executive Officer of Alaska Airlines

Brandon S. Pedersen - Chief Financial Officer, Principal Accounting Officer, Vice President of Finance, Member of Management Executive Committee and Vice President of Finance-Alaska Airlines Inc

Mark Eliasen - Vice President of Finance

Joseph A. Sprague - Vice President of Air Cargo and Member of Management Executive Committee

Andrew Harrison - Member of Management Executive Committee and Vice President of Planning & Revenue Management for Alaska Airlines, Inc.

Benito Minicucci - Member of Management Executive Committee, Chief Operating Officer of Alaska Airlines and Executive Vice President of Operations for Alaska Airlines

Analysts

Duane Pfennigwerth - Evercore Partners Inc., Research Division

Hunter K. Keay - Wolfe Research, LLC

Helane R. Becker - Cowen and Company, LLC, Research Division

Michael Linenberg - Deutsche Bank AG, Research Division

John D. Godyn - Morgan Stanley, Research Division

Savanthi Syth - Raymond James & Associates, Inc., Research Division

Operator

Good morning. My name is Sarah, and I'll be your conference operator today. At this time, I would like to welcome everyone to the Alaska Air Group Investor Update Conference Call. Today's call is being recorded and will be accessible for future playback at www.alaskaair.com. [Operator Instructions] I would now like to turn the call over to Alaska Air Group's Managing Director of Investor Relations, Chris Berry.

Chris Berry

Thank you, Sarah. Good morning, everyone, and thank you for joining us today for a special investor update presentation. If you are participating via the conference call and have not yet logged into the webcast at alaskaair.com/investors, I would encourage you to do that now as there is a slide presentation we will be referencing today.

For this update, we will discuss our enhanced capital allocation strategy, including the initiation of a quarterly dividend announced this morning, an update to our hedging program, changes to our ancillary fee policies and other revenue opportunities, an updated capacity outlook and some other matters. I'm joined today on the call by Brad Tilden, our CEO; Brandon Pedersen, our CFO; Mark Eliasen, our Vice President of Finance and Treasurer; Joe Sprague, our Vice President of Marketing; Andrew Harrison, our Vice President of Planning and Revenue Management; and Ben Minicucci, our Chief Operating Officer.

As usual, our comments today will include forward-looking statements regarding our future expectation, which may differ significantly from actual results. Information on risk factors that could affect our business can be found in our SEC filings available on our website.

Finally, I would like to ask that during the Q&A portion of the call, you limit your questions to the topics discussed today and not on second quarter earnings or other topics. We expect the presentation with Q&A to be approximately 45 minutes in length.

With that, I'll turn the call over to Brad.

Bradley D. Tilden

Thanks, Chris, and good morning, everyone. We're very happy to be talking with you all. And as you've seen this morning, we announced that Alaska will begin paying a dividend of $0.20 per share per quarter or $0.80 per year. This dividend will be in addition to our very significant share repurchase program, and at the current stock price, it will provide a yield to our investors of 1.4%.

Most of you have been following us for a long time. And you know that our goal here, what we've been trying to accomplish, is to build a fundamentally strong company. And by that, we mean a company that's safe, a company that operates well, you've seen our numbers there, a company that's good for customers, that provides good customer service and good value to our customers. We wanted to build a company that's a good place to work. And when the company does well, share the results of that success with our employees through incentive plans and so forth. And finally, we wanted to be a good place to invest, not a good place to trade, but a good place to invest.

One of the questions we've asked ourselves over the years is whether or not this is a good place to invest. Sometimes, we ask ourselves whether it's a stock that you'd recommend for your parents.

With the earnings that we've been generating over the last several years, I think we've been headed in the right direction for several years. And today's news of a dividend just makes a stronger case for this being a good place to invest.

Of course, the dividend is just one aspect of a broader capital deployment plan. Our business is generating cash flows now, something like $3 billion over the last 5 years. Brandon will share detail on this in just a moment, but these cash flows have enabled us to do all sorts of great things for our business.

We've substantially rejuvenated our fleet with new, larger, fuel-efficient airplanes that enable us to get into the market and compete very, very effectively. We've paid down a ton of long-term debt. We funded our pensions to the extent that those are really not an issue for this company. And more and more, in the last couple of years, we've turned to investors, we've provided substantial share repurchases and, today, we're announcing that we're going to pay a cash dividend.

It's worth taking a minute to focus on the very substantial improvements on our balance sheet that have come from our cash flows from operations. We think that most good companies pay dividends and our goal for many years now has been not to be just a good airline but a good company. We're very proud to be taking this step today, as it reflects our confidence in the terrific people that make up Alaska and Horizon and our confidence in the underlying strength of our business.

There are several other changes, important changes, in our business, which we've either announced in the last few days or which we're announcing today. We've been working on most of these for many, many months now, and it just sort of happens that they all come here to get it here on Thursday, July 11, but we're really excited to be announcing all of these news to you.

First of all, we were extremely pleased to hear, yesterday, that our tentative agreement with our pilots for a new five-year agreement was ratified by 67% of our pilots. In this business, you have to operate well. And to operate well, everyone in the company needs to be aligned and headed in the same direction. This agreement gives us the chance to fully focus on on our operation, our customers and our competition for the next 5 years. And I cannot be more happy to have our Alaska pilots fully engaged in this effort and leading the charge.

Second, we're announcing today that we have a new five-year agreement with Bank of America on our credit card program. We expect that this deal would generate an additional $55 million of cash at today's volumes.

Third, as you saw on Tuesday, we announced the increases in our fees for our first and second bags and increases in our change fees. Andrew will talk more about these in a moment, but we estimate that they will bring in an additional $50 million of annual revenue.

As you all know very well, there are many components, some of which can be quantified and known, and some of which can't. So we'd caution you from doing too much simple math with these changes. However, we will say that they are powerful profit drivers that will enhance our results in the future.

Finally, while we're on the call this morning, we're going to use this opportunity to talk you through a series of changes we've made to our fuel hedging program. We'll talk with you about the economic power of the new seats which we'll be introducing this fall. And we will talk with you about capacity changes in our markets.

Thanks very much for your interest in ALK. Thanks for being with us this morning. I think we have a slide that we're going to pop up that will show you some details on the dividend. And then after we take a look at the slide for a brief moment, we'll turn it over to Brandon. Thank you.

Brandon S. Pedersen

Good morning, everybody. This is Brandon. It's a pleasure to be with you all today. If we turn to the next slide, Slide 5, as many of you know, return on invested capital has been this company's north star, financially speaking, for about 10 years now. We've actually been a leader in this regard and, as many of you know, our business transformation plan over the last 10 years, whether it was under the banner of the 2010 plan, the Horizon transformation plan or, now, the 5 focus areas, has resulted in our business achieving consistent ROIC in excess of our weighted average cost of capital and strong cash flows. The 2 charts that you see on the page demonstrate that. On the left, you'll see return on invested capital. We've been exceeding our 10% goal now for 4 years in a row and, importantly, we're generating roughly 600 basis points of economic value with $3.2 billion of invested capital.

On the right-hand side, you see our operating cash flow. If you sum all the operating cash flow up since the beginning of 2009, we've generated roughly $2.5 billion in operating cash flow. And by the time we get to the end of 2013, that number will be roughly $3 billion.

Turning to the next page, one of the things that is a hallmark of Alaska is fair and balanced disclosure. So we don't only want talk about our ROIC, we want to compare that to others in the industry.

The table on the left-hand side depicts ROIC as reported by various carriers. But as many of you know, there are lots of ways to calculate ROIC and -- excuse me, ROIC. And when we take everybody on the same basis, you can see that we still rank very well compared to our peers. Of course, everybody has a different cost of capital, so the economic value added would differ for everybody.

If we look at the way we've deployed our capital since the beginning of 2009, in other words, how we've used that $2.5 billion of cash flow, it's been in a very deliberate way. And we're illustrating this with a stacked chart and I'll go through each of the blocks. First, we've invested roughly $1.6 billion into the fleet, other assets and technology. If you look at the fleet at the end of 2008, we had 110 airplanes. Since that time, we've taken delivery of 28 new 800 and 900ER aircraft. And we've been able to retire 10 older and smaller airplanes for a net increase of 18 airplanes. And it's important to note that nearly all of those 28 airplanes were paid for with the cash.

Second, we've reduced leverage in our business. This company and, generally, the industry, has had too much debt. We had a debt to cap ratio of 81%. We'll be under 50% by the end of this year. We've used roughly $1.4 billion to retire debt and lease obligations.

Third, as Brad said, we've managed our pension obligations. We've contributed more than $550 million to our pension plans, even though none was required. I'll spend a little more talking about that in a few moments.

And then, finally, we've been a leader in returning capital to shareholders. Back to 2007, through a series of repurchase programs that culminated with a $250 million repurchase program authorized last fall that represented about 10% of the market cap of the company. Our announcement today about a dividend is the next logical step for us in terms of capital allocation.

I mentioned the aircraft investments, here's what we've gotten for our money. We have one of the youngest fleets in the industry. Our average fleet age is 8.5 years, and it will continue to stay young as we retire our 737-400 fleet between now and the end of 2017.

It's also important to note there our gauge is up approximately 8% since the end of 2008. This works really well for us in our point-to-point network, where we have a few frequencies between the Pacific Northwest, say, and the East Coast, where larger airplanes are the right tool for us.

On the right-hand side, you see how our fuel efficiency compares to others in the industry. This is important, obviously, with fuel being roughly a third of our operating cost. It's also interesting to note that on this metric, we've improved by roughly 13% in the last 5 years.

Not shown on the slide, but equally as important, is the progress we've made on the Horizon side. Horizon's 48 Q400s are exceptionally fuel efficient and have an average age of roughly 7 years.

Our future capital spending is also positioning us well to continue free cash flow. What you see here is the CapEx that we expect to have over the next 5 years or so to keep our feet flat, as well as invest in other things that we have planned, whether they be things that improve productivity, reduce costs or enhance the customer experience. In the box below the chart, you'll see that the option, the CapEx that we could spend on options for growth, assuming we can do so profitably.

Next slide, please. As I said, we've reduced our net debt by roughly $1.4 billion since the beginning of 2009. Our debt to cap was at 81% at the time, now it's down to roughly 50%. One thing that is really a cool feature of this is that we've taken our interest expense from about $105 million a year to about $63 million a year. That $40 million improvement in interest expense is significant.

And as a result of the work that we've done on the debt, our debt to cap ratio now positions us to be one of the best in the airline industry. But it also makes us look good compared to other high-quality industrial companies. The companies that we've chosen as comparable companies on this slide are comps that you all have recommended to us because they illustrate what good industrial companies -- or examples of good industrial companies.

And as a result of our strong cash flows and our debt reduction initiatives, our ability to meet our debt obligations is among the industry's best. Simply put, what this slide illustrates is that we could retire our net debt with about 6 months of EBITDAR.

I mentioned that our pensions are well funded and the magnitude of the voluntary contributions that we've made since the beginning of 2009. I might start on the right-hand side of this chart, where we compare our funded status to the others in the industry. At the end of 2012, our company was a [ph] plan where 82% funded within an unfunded obligation of roughly $300 million. And you can see how that compares to others with DB [ph] plans in our business.

Moving to the left-hand side, what we do is we compare the balance at the end of 2008 to the balance now that reflects the current interest rate environment as well as return on plan assets since the beginning of the year. We believe our unfunded obligation is currently around $100 million with a 90% or so funded status.

In the points below, I'll draw your attention to just one, that is a 25 basis point increase in the discount rate. By our calculation was -- would result in our plans being roughly 100% funded by the end of this year.

On the next slide, the point of this slide is to illustrate that we can be fully funded by the end of 2014, if our current interest rate assumption stays in place, 4.85%, and our plans earn the 7.25% rate of return that we use in our assumption. Our requirement, the bottom line here is that our requirement to fund our pensions with cash to be fully funded is basically negligible.

And working up the stacked chart, this of the culmination of it. We've been active returning approximately $325 million, or we will return approximately $325 million to shareholders over a two-year period, 2013 and 2014. That assumes, of course, that we have -- we execute on our $250 million authorization, what's remaining, which is, of course, the plan, as well as pay a $0.20 dividend in the remaining time in 2013, as well as the full year of 2014. Of course, that's subject to board approval, and the $0.20 is just for illustrative purposes only. But the point being is that we will return a very significant percentage of our free cash flow and net income to investors over a two-year period.

And finally, before I turn the microphone over to Mark, I'd like to spend a minute discussing the seats. I don't think investors have appreciated the magnitude, or the impact, of the seat project and what it will do for us, both on the revenue side and the cost reduction side. I won't walk through the math, but what we wanted to do on the left-hand side is provide investors, really, a tally of how we got to our annual estimated revenue impact of $47 million, which we believe this will contribute once fully implemented by the end of next year.

On the cost reduction side, we've talked broadly about how the 474 seats that we'll be adding to the fleet have resulted in -- or that will result in a roughly 2.5% increase in seats and a commensurate reduction in unit cost. What an important message is, is that when you look at it, just in terms of the work on the 800 and 900ER -- excuse me, the 800 and 900 fleet, it's about a 3.5% or 3.3% reduction in CASM on an average flight. Very powerful, indeed.

I'd like to turn the call over to Mark at this point.

Mark Eliasen

Good morning, everyone. This slide illustrates some changes -- or adjustments we've been making to our hedging program. And as you can see on the left, if you look at our historical program, which had served the company well, we were spending about $9 a barrel. What we're -- what I'd like to illustrate today, or talk about, is on the last bar here, in the green box. You can see that we're now starting to hedge 18 months in advance instead of 36. And we'll reach our hedge target, a 50% hedge level this month in advance. This means that our premiums are actually going to be down $35 million per year. And really, the change is affordable because the company is stronger now than we were when we initially started hedging.

Let's go to the next slide. I'd just like the mentioned that the fundamentals of our hedge program remain unchanged. We are still hedging 50% of our consumption using WTI call options. And we're still using some short-term refining margin swaps for jet fuel protection.

If you go to the next slide, you'll see that, in the event fuel prices do spike, our protection does cover us for 6 months. That buys us time for the industry to adjust to higher fuel costs. As this slide shows, these changes keep us consistent with the industry.

Now from an accounting standpoint, it will take time for our older hedges to run out. But the real issue here, the real benefit is that the reduction in tenor reduces the cash we are paying today to hedge. Our new run rate is roughly $15 million per year.

Okay. So now Joe Sprague, our Vice President in Marketing, will speak.

Joseph A. Sprague

Thanks, Mark. An important program at Alaska Airlines is our Mileage Plan Frequent Flyer Program. It's popular and seeing solid growth, thanks, in part, to the added value we offer customers by providing award travel access to hundreds of global destinations through our airline partners.

An important component of our mileage plan is our Visa affinity card program. Last week, in fact, on July 2, we executed a new multiyear agreement with our longtime partner, Bank of America, that includes a number of enhancements over our previous contract, including an improved rate per mile that will result in an additional $55 million per year in cash flow. We're delighted to have this new agreement in place and to be moving forward to further build this successful program. One note, the financial reporting around this is complicated. And we'll have more to say on that aspect of it in the very near future.

And now, our Vice President of Revenue Management and Planning, Andrew Harrison will take over.

Andrew Harrison

Thanks, Joe. I think it's fair to say that bag fees and change fees have become an integral part of the U.S. airline industry's business model. And we've recently taken a deep dive into our change fees and bag fees. And as you saw this past Tuesday, we made some changes to those fees and increased them.

I want to point out that our second bag and our third bag, and even our change fees, are still one of the lowest in the industry today. And we are still the only carrier to offer a 20-minute bag guarantee. While doing that, we've been able to increase our revenues from these fees by about $50 million a year.

I want to talk a little bit about capacity and some growth concerns that we've heard out in the marketplace. To start, I will acknowledge that our unit revenues for the past 2 quarters have lagged the industry. But that said, if you go to end of 2012, and you look at our absolute PRASM on a stage length adjusted basis, we have exceeded the industry's PRASM for the past 16 quarters. And then if you look at this slide here, what we're demonstrating is, over the last 6 years, we've been able to increase our load factor every year and cumulatively by 10 points by growing 14%, while the industry has had no growth and only increased by 3 points. The point of this slide is just to reiterate that we will continue to be agile and very disciplined as it relates to our capacity.

As we look forward into the summer, we have made adjustments to our summer schedule. In fact, we've reduced our departures by 2% by cutting certain markets that were not performing at expectations. I'll draw your eye to Hawaii, which we've talked a lot about, and you can see there the number of cuts we've made. I'm pleased to report that of the Hawaiian markets that we have reduced this summer, as we look forward, we are seeing double-digit unit revenue growth from these cuts. I'm encouraging not to go adjusting your models yet. You've seen our second quarter, but we'll be talking more about this as we move forward in the next couple of weeks for our second earnings call. That said, I will say that, as we sit here today, we are seeing solid summer demand.

If we look forward to the winter, we've recently made, on June 16, additional cuts to our winter network. We pulled out 10 frequencies to Hawaii per week and 8 transcon frequencies, that's a total of 18 aircraft per week that we will not be flying in the winter to better match demand with supply. This is the first first time we've ever done these day-of-week cuts, and we'll be watching them closely.

On the second quarter call, I may have caused some angst with some of you as we discussed competitive capacity increases. And I'd like to put some of that into perspective.

What we see here is, indeed, in the third quarter, competitive capacity does peak in our network. But you can see that, of that 10%, over half is related to Alaska long-haul. And you can see there on the bottom, what that really translates into is about 7.5 flights per day across the entire lower 48 into the state of Alaska. And that compares to our 30-plus flights today that we fly into the state of Alaska. We only had about 2.3% increase in capacity for the third quarter, and a lot of that is gauged.

The point here I want to make is, is that competitors come and go in the state of Alaska, and we've seen that for many, many years. We are going to stay the course and you should not expect any major capacity adjustments from us as it relates to the state of Alaska. But we're going to continue to work our brand and our network strength and our tools in our tool chest to manage these competitive incursions.

Some other areas of weakness in our -- past couple of quarters in our unit revenue is being new markets. And if you fast forward to the end of this year, we will have started 35 new markets over the past 2 years. I want to be clear, that as we go into 2014, this will slow. We'll talk more about that later on in the year. But I also want to reiterate there's been no horror stories with these new markets. They are maturing, but we will cull flights that don't meet expectations. And we'll do that in a timely manner.

And in the last slide I want to end on, we field a lot of questions from you on Delta. And as many of you know, we have a long relationship with Northwest. And then 5 years ago, when Delta and Northwest merged, we entered into a deeper, long-term relationship with Delta. Of course, there's been bumps along the road, like any good relationship. But I want to point out here that it's been evolving and strengthening. And what you see here is a map, and what Delta's been doing over the past 3 years, which has really peaked this summer, is building an international gateway in Seattle. And you can see that their capacity is up by 41% this summer.

International gateways are critical. Their success is critical to getting flow. The actual local demand out of a gateway is small and so you need an expansive, cost-effective and reliable domestic network to feed that gateway. And that's where Alaska Airlines and Alaska Air Group and Delta can work together to create great success. You've see us add core adds, in markets like Los Angeles, Las Vegas and Phoenix. We've adjusted our schedule. This is all to better position our domestic networks to feed this valuable international growth, both to Delta and to us.

And to put a point on this, Delta's been very public about making Seattle the #1 gateway to Asia. And if you look at the feed into Asia, across the West Coast, 90% of that feed comes from 7 markets. And those 7 -- or 7 cities, I should say, and those 7 cities are core to our network which we can serve very well.

American Airlines is also an extremely important partner. And as U.S. Airways and American come together later on this year, we'll be updating you more on that relationship as we connect with them in the fourth quarter.

And with that, I'm going to hand the call over to our Chief Operating Officer, Ben Minicucci.

Benito Minicucci

Thanks, Andrew, and good morning, everybody. I'm very happy and extremely pleased to announce that the tentative agreement we had our pilots was ratified yesterday. Alaska has one is the most talented and productive pilot groups in the industry and this agreement acknowledges that.

Some highlights of the agreement: It's a five-year deal with date of signing increase of 10.8%, with downline increases of 1.5%, 1.5%, 3.5% and 1.5%. The deal is worth $30 million annually, and this year, we expect a $23 million cost impact.

I'm extremely pleased that we were able to work with ALPA to come to a long-term agreement, and I do want to thank them for their outmost professionalism and leadership. 5 years is our longest ever pilot contract. It allows us to focus on running the business together to ensure a healthy and vibrant company in the future.

I also want to update you on our current lease negotiations at Sea-Tac Airport. First, I'd like to say that we have been long standing partners with the Port of Seattle over many years, given that Seattle is our hub. We have worked hard together to make the airport efficient and, I think, jointly we've been successful, given our #1 on-time track record in the past 4 years. Although we have been negotiating for the better part of the year with the Port of Seattle, we have not been able to reach a deal yet.

Unfortunately, the port recently imposed rate increases on all airlines. For Alaska, it represents about $23 million annual increase retroactive back to January 1. We are continuing to negotiate with them. And we are really optimistic we can strike a deal that benefits Alaska, the Port of Seattle, and in fact, all airlines at Sea-Tac, at rates that are lower than the imposed $23 million per year. These rate increases led to our slight upward guidance on consolidated CASM that you saw in our investor update that we filed on Tuesday.

And with that, I'll turn it back over to Brad.

Bradley D. Tilden

Thanks, Ben, very much. So yes, thanks, everybody, for getting on the call this morning. We're super excited about the performance of the business, the strength of the underlying cash flows, what they're enabling us to do with our balance sheet and our future. We're very, very excited to be announcing the dividend today. I think the number of the profit drivers that we've talked about are worth focusing on, the network changes that Andrew talked about. We didn't mention specifically yet, but bringing Q400s to the state of Alaska will just continue the strength of putting the right airplane in the right market and helping us make money. The additional seats that we are putting into our 800 and 900ERs and 900s that start this fall, will bring unit costs down, will bring new revenues the company. The bag fee and change fee changes will bring new revenue. The affinity card agreement and -- I don't want to make you too nervous with the accounting, it's $55 million of profit a year. And Brandon, you'll have to tell us exactly how we've booked that, but that is coming our way.

And then finally, these long-term labor deals. I don't think you can underestimate the value of having everybody in the boat, rowing the boat in the same direction, so that the entire team can focus on moving the company forward. And we've done long-term deals now with several of our groups. Pilots having a deal, Ben, this takes us through 2018?

Benito Minicucci

2018.

Bradley D. Tilden

2018. So it's just a fantastic opportunity for us to continue to do great things for all of our constituents, our customers, our employees and you, our owners.

So thanks very much. We are available for questions. And we look forward to hearing what you want to talk about.

Chris Berry

Okay. Sarah, you can prompt for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Duane Pfennigwerth with Evercore.

Duane Pfennigwerth - Evercore Partners Inc., Research Division

I just wanted to ask you about your leverage targets. Given how much it's come down and you've effectively delevered the balance sheet, as we look out over the next couple of years, it seems like you could choose to be effectively done with deleveraging maybe the middle of next year. Just wondering if you could put out a target on where you want to take leverage and to the extent that you stop deleveraging, how should we be thinking about the excess cash flow going forward.

Brandon S. Pedersen

Duane, it's Brandon. The leverage thing, I've said for a long time that there has just simply been too much debt in this industry and in the business, generally. We went, as I said, from 81% debt to cap down to about 50% now. I have thrown out a target of being between 40% and 50%. And the reason that we do that is to say, what do high-quality industrial companies have generally. That's not to say that we would necessarily be there permanently. I think you can get to a point where you wouldn't go below 40% just because it is -- that there's some logic to having leverage of a -- some leverage, of course. So I'm reluctant to have a target. But I think you're on the right path when you say that we wouldn't do too much more deleveraging beyond what we have in terms of normal debt repayment scheduled over the next year or so.

Duane Pfennigwerth - Evercore Partners Inc., Research Division

And to the extent you hit that 40% next year, how should we be thinking about the funds that you'd otherwise be using for...

Brandon S. Pedersen

Yes, and again, I wouldn't lock onto 40% because I think we want to do some more work around that. It's just -- I'd call that a talking point. But I think it's -- your point -- your question is really, when we got to some number, whether it be 40% or 50%, whatever the right number is, what would we do with the cash. Well, we have -- we only have a few options, right? We wouldn't keep it in our checking account, making basically nothing. And we have a process where we go out and buy airplanes based on market opportunities that we see. I think we've done a pretty decent job laying out what our CapEx plan as well as our options could be. And to the extent your model is generating incremental cash flow above that, it wouldn't sit in the checking account. It wouldn't be used to buy more airplanes just for the sake of buying airplanes. I think the simple answer is, is that we would want to do something in the form of returning it to shareholders.

Duane Pfennigwerth - Evercore Partners Inc., Research Division

And then just lastly, can you just tell us where your unencumbered assets -- the value of those stand today?

Brandon S. Pedersen

Yes. it's hard to know exactly what the value of the unencumbered assets is. There was a chart with a box that noted that we had 35 unencumbered Boeing 737, 800 and 900ER. If you rack up all the unencumbered airplanes in the fleet, it's 48 on the Alaska side and 7 on the Horizon side. In terms of the value, I would -- I'll let you do that math. But I would say, the vast majority of the airplanes that are unencumbered are new and valuable 737NG aircraft.

Duane Pfennigwerth - Evercore Partners Inc., Research Division

Okay, I'll ask you a different way. if you wanted to lever those up, how much could you raise against those assets today?

Brandon S. Pedersen

And I'll answer it the same way.

Operator

Your next question comes from the line of Hunter Keay with Wolf Research.

Hunter K. Keay - Wolfe Research, LLC

Thanks for exhausting all of my questions for the next 2 years. No, this is remarkable, really. So let's go back to last year. Your stock was flat for about 5 to 6 months. And then you did a $250 million buyback program. And then your stock started to work again. And now your stock has been under some pressure and you did this. So I'm wondering, did you -- what was the impetus behind this initiative? Was it because your stock was down? Or was it because you were hearing it from your investors because you went on and actively asked them? Or, obviously, the 2 are related, but how did you get to this decision today? What was the final sort of straw that made you go to the board and say, we got to do something? How did you get there?

Bradley D. Tilden

Hunter, we've been -- when you get this question, you can't -- until you've done something, you can't really talk about it. But I think we're probably okay talking a little bit about the history now. But we've been talking to the board about this for at least a year. And it's been in our sights to do, I think, for at least 6 months. But we just -- I think, you put out a note. We are methodical and we are thoughtful. And we kind of -- it's sort of a balance sheet decision. And so we were deliberate about it. But no, I think, this decision was -- there was a very strong indication that we were headed this direction after our May board meeting, which was in early May. Anyway, that's a bit of the background. Several of the -- it is an odd week for Alaska Air, but I'll tell you that we've got so much news that happened to get done right now. The pilot deal, we heard about it at 8:00 yesterday morning. The bank deal, we just -- Joe, that was July...

Joseph A. Sprague

July.

Bradley D. Tilden

Last week, that, that bank deal got done. The change fees are something that we have been studying and watching the industry on. It's just -- a lot of the stuff just sort of came together now. I'll just say this, Hunter. I don't think it's -- I think it's good for us as a leadership team to focus on the long-term needs of all of our stakeholder groups, the long-term needs of customers, the long-term needs of our employees, the long-term needs of our owners. And I don't think it would be right for us to be overly focused on the short term with any of those stakeholder groups.

Hunter K. Keay - Wolfe Research, LLC

Sure. No, of course. Yes, that's great. And Brad, as much as you can, let us into the dynamic of that board meeting. I mean, I assume it wasn't just a unanimous discussion, a unanimous decision to do this type of stuff. Did you talk about bag fees and change fees with them? Did you have to get approval for them? And on the capital deployment, what was the pushback that you heard from some of your more conservative board members? Was it, gee, we hate to come -- we had to do this thing and cut it? Or is this enough? I mean, did you have to convince some of your more conservative or methodical board members to get here?

Bradley D. Tilden

No, I don't know if it's right to get into all of the inner workings of the boardroom. But I will tell you that we have an extremely supportive Board of Directors. They are very enthusiastic about our approach to shareholders, this whole notion of us leading this charge with ROIC. And then -- one question I was going to throw in to Duane, I decided not to, is that, I mean, the big focus with us and the board is on generating the return. It's kind of managing the invested capital base and generating the returns. This issue of what do you do with it when you have it, that's not something we spend nearly as much time with. I think the only -- I think the board, if you were to generalize it, they've been very, very supportive of this idea all along. There is a recognition that we need to pay this dividend. So this isn't -- we didn't announce to give dividend for come quarter, we announced the commitment to pay dividends to our owners in the future. And so that -- if there's a little bit of caution or care, it's probably -- it's with that recognition. That's probably what we feel comfortable talking about.

Operator

Your next question comes from the line of Helane Becker with Cowen Securities.

Helane R. Becker - Cowen and Company, LLC, Research Division

Thanks for doing the dividend. My question is with respect to return on capital. Are you moving the return on capital target above 10%?

Brandon S. Pedersen

Helane, it's Brandon. Good morning. No, we are not. Our goal is to generate a 10% return on capital over the business cycle. And we've had 4 great years now, or we will have 4 great years where we will exceed that goal. But I don't think we've been through a business cycle yet. So before we go change the target, we're going to prove to ourselves that 10% is achievable. I think the dividend today is a signal that we have a lot of confidence that it is. But we have no reason to change the target at this point.

Bradley D. Tilden

Brandon, we have to have years with 13s to make up for the years we've had with 7s.

Brandon S. Pedersen

For sure.

Helane R. Becker - Cowen and Company, LLC, Research Division

Okay. That was -- I just kind of wanted to know about that. And I appreciate the dividend and all the other color.

Operator

Your next question comes from the line of Michael Linenberg with Deutsche Bank.

Michael Linenberg - Deutsche Bank AG, Research Division

A couple of questions. And maybe this one, the first one to Ben. On the pilot contract. As I recall, they were -- the old contract, I believe, had some productivity features that were good. And my question to you is, are those preserved? And then going forward, are there may be additional benefits that you picked up, as it relates to productivity with the new contract?

Benito Minicucci

Yes, Michael. Yes, absolutely. We preserved them and we actually enhanced productivity in this new contract. So you'll -- right now, today, we're in top 2 or 3 for productivity for pilots in the industry. And our goal is to be up there as the best productive pilot group in the industry. We have terrific, terrific pilots. We have a great union that we work with every day. And they're proud of the operation they are on. We are proud of our product -- we're proud of our performance. And this contract, I think, is going to take us higher, to a higher place than we were with this last one.

Michael Linenberg - Deutsche Bank AG, Research Division

Okay, great. And then just my second question, maybe this is -- it's a little more technical, to Brandon, on the pension. The moving from 82% at year end to the estimated 90% funded status of the plan at the end of June, is that a function in the change of the discount rate? Or is that a function of the improvement in the return on assets, given the upward movement in the markets?

Brandon S. Pedersen

It's really both. The discount rate is probably the bigger piece of that.

Operator

Your next question comes from the line of John Godyn with Morgan Stanley.

John D. Godyn - Morgan Stanley, Research Division

First, I just wanted to understand your own view on whether you think you are returning capital to shareholders in an efficient way. I guess, maybe the other way I'd ask that is, if you didn't grow earnings over the next 3 years, would we expect to see buyback increases and dividend increases from here?

Brandon S. Pedersen

John, it's Brandon. Can you ask your question one more time, the last part?

John D. Godyn - Morgan Stanley, Research Division

Yes. So I guess, for context, one of the things that I often hear from investors is that you guys may not be returning capital as efficiently as you could. In other words, you have capacity to do more.

Brandon S. Pedersen

Yes. You know what? I would say to that, that we have been leaders in returning capital to shareholders, going back to 2007. And we've been very thoughtful and deliberate about our broader capital allocation strategy. As I said, it was very deliberate. First, we wanted to get our debt balance under control and delever the balance sheet. We wanted to invest in the fleet and get to a single fleet of really efficient airplanes on the Alaska side and on the Horizon side, single fleet of both airlines. We wanted to take care of the pension funding problem, and then -- not problem, but -- we wanted to make sure our pensions were well funded. And then we wanted to return capital to the shareholders. And I don't think you can look at any other company in our industry and see a company that has done more in that regard than we have. We're super pleased with what we've accomplished and we are super pleased about being able to offer the dividend. So I guess, I don't have any -- I mean that people can judge us based on our actions, but I am very comfortable that our actions have met the test of efficient.

John D. Godyn - Morgan Stanley, Research Division

Sure, totally fair. But just to get back to the point here. If your earnings didn't grow over the next 3 years and we just sort of had steady-state economics, do you think that you could increase the buyback and dividend from here?

Brandon S. Pedersen

Our goal would be to increase earnings.

John D. Godyn - Morgan Stanley, Research Division

Okay. And if I could just ask some questions on some of the commentary out of Andrew. Andrew, I think you mentioned that demand is strong. We often hear these words strong, solid. It's very difficult to sort of understand exactly what that means, but we hear it every quarter from the airlines, whether PRASM's negative or positive sometimes. Is it fair to assume that, again, I'm not looking for guidance, here, but you guys have been doing PRASM, it's down 4% or so recently, is it fair to assume that strong indicates an improvement in that rate of change to some degree?

Andrew Harrison

John, I'm going to, as I said before, share more details in the next couple of weeks. But I think -- when I talk about my comments today, when I talk about strong, it's where we thought it was going to be. There's no major variations for where we thought it was going to be. And it's coming in right where we set out capacity to expect demand to come in. So I think that's sort of where I'll leave it for now.

John D. Godyn - Morgan Stanley, Research Division

Okay, fair enough. And on the comments on Alaska and capacity and then Delta's actions in Seattle for Alaska, I think you mentioned that it's not uncommon for airlines to come and go. Clearly, they're coming right now. Do you have any reason to believe that they're going? That they are exiting the markets, that this capacity that we're seeing is going to go away?

Andrew Harrison

I don't have the crystal ball. But what I do know is that some of the carriers that has entered the state of Alaska in certain points on their map are way off the reservation from their core network. And so my point is only that we have a very strong and powerful Alaska network, and we're going to stay the course. And these other carriers will either be successful or they will not. But from my perspective, they will not.

John D. Godyn - Morgan Stanley, Research Division

Got it. And then on the Delta part of it, in Seattle. Sometimes the argument that I hear is, you certainly have a great relationship with Delta, but you're also making a lot of money on some of those routes and some of those feeder routes. Why, in spite of your great relationship and your great network and the value you have to offer, why do you think it doesn't make sense for Delta to fly those flights on its own?

Andrew Harrison

Delta is going to do what Delta needs to do for their network, and we will do the same. And that's a little bit hard for me to comment on.

Bradley D. Tilden

John, thanks for the great questions. I want to just come back on the capital. We've said this many, many times, but I want to make sure we're really clear. As we think about growth and we think about putting x million dollars into a new airplane, what we always think about, is the returns on that capital going to exceed 10% over the life of the investment. So when you -- your questions are kind of getting at, will you keep on buying airplanes if earnings aren't going up. No, if we're investing capital, we've got to believe that we've got long-term returns that exceed our cost of capital. The other point that it's just -- I think it's what we're all talking about, is that the last couple of years, we've had an opportunity to fund pensions and pay down debt. That opportunity isn't there to the same extent in the future that it has been in the past. So there will be more returns that we've got to continue to think about what to do with in the future.

John D. Godyn - Morgan Stanley, Research Division

I appreciate both these points. If I could just ask a couple of follow-ups there. And if I remember correctly, I think the last we heard was your long-term capacity growth guidance was 4% to 8%. Is that still the case, as we look out the next few years? And then on your pension point, how would an over-funded pension change your thought process around shareholder returns?

Bradley D. Tilden

John, I'll do the first and I'll let Brandon do the pension one. But just to be really clear. Our growth idea is if over the longer term, we'd like to grow the business 4% to 8%, profits permitting. And so that's the mindset. And I think what Andrew is saying, we've had a ton of growth the last 2 or 3 years. We've had an incredible run in Hawaii. And now we're in a mode where we're probably digesting that growth. And you may not see quite see as much for the next few quarters in terms of announcements. And then we just need to -- we don't have to decide for 2 or 3 or 4 years, what we'll exactly do. But the mode we're in, right at this moment, is digesting growth, sort of making sure it works, make sure the flying we're doing does cover our 10% hurdle rate. And we'll think about the future as we move forward.

Brandon S. Pedersen

John, it's Brandon. Maybe just to wrap up with your question on the pension, in terms of what happens if we are over-funded, it would be a temporary situation. I think the point we were trying to convey is that our pensions are in really good shape. And we don't have a required funding but we may choose to do some. In terms of over-funding, it's really just a matter of time of letting the benefit payments catch up with that, because we do have $1.8 billion, $1.9 billion worth of obligation that, again, are well funded. But to the extent that we just need time to catch that back up, that wouldn't be such a bad thing, anyway.

Chris Berry

Sarah, we have time for one more question.

Operator

Our last question comes from the line of Savi Synth with Raymond James.

Savanthi Syth - Raymond James & Associates, Inc., Research Division

On the dividend, I was wondering how you came up with that level of payment?

Brandon S. Pedersen

Well, Savi, thank you for finishing up the Q&A with a question about the dividend, which is really our headline story today. That's great. For us, it was a couple of things. One is we did a lot of research in our very methodical and deliberate way here at Alaska. We did a lot of research on what successful companies initiate at. And the evidence points to between a 1% and a 2% yield. So we wanted to meet that threshold. We wanted to do something that would position the company to regularly also grow the dividend in the future. That's the goal. Obviously, our board will make decisions as time moves on and we survey the landscape in terms of profitability and other cash needs, et cetera, et cetera. But it was really those 2 things, what the prominent practice was in terms of new initiations and where that was in terms of yield, and the other is positioning us at a level where we can regularly grow the dividend in the future.

Savanthi Syth - Raymond James & Associates, Inc., Research Division

Understood. And if I may follow up on the growth question, is the consolidation of -- not opening new markets, I understand that, but does that change, maybe for 2014, what your capacity growth would look like?

Brandon S. Pedersen

We haven't given any capacity guidance yet for 2014. I think the main point is the one that Andrew articulated very well, which is, we have done a lot in terms of new market growth in the last couple of years. And I think you'll see that slow as we move into 2014, to give us opportunity to digest some of that growth and mature those markets.

Chris Berry

Okay, everybody, thank you for getting on for this special call. And we are looking forward to talking with you in just a couple of weeks. Thanks very much. Have a good day.

Operator

Thank you for participating in today's conference call. This call will be available for replay beginning at 1:30 p.m. Eastern Time. Today, 11:59 p.m., Eastern Time, on August 11, 2013. The conference ID number for the replay is 16687842. The number to dial for the replay is 1 (800) 585-8367 or 1 (404) 537-3406. The call will also be accessible for future playback at www.alaskaair.com. You may now disconnect.

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