On Tuesday morning, Delta Air Lines (DAL 0.79%) reported a fourth-quarter adjusted pre-tax profit of $1 billion, bringing its adjusted pre-tax profit for the year to a record $4.5 billion. Delta's announcement marks the beginning of what is sure to be a string of solid earnings reports across the industry, thanks to a sharp drop in the price of jet fuel since September.
As good as Delta's performance was in 2014, management expects even stronger performance in 2015 across virtually all key metrics. Profit growth will remain rapid thanks to lower jet fuel prices.
By the numbers
Delta's Q4 revenue rose 6% to $9.65 billion, ahead of the average analyst estimate of $9.58 billion. Passenger revenue per available seat mile, or PRASM, increased 0.8%, while non-fuel unit costs increased just 0.5% and fuel expense fell $342 million year over year, even after accounting for hedging losses that settled last quarter.
Delta's PRASM result was slightly worse than the forecast that it had provided at its Investor Day in December. However, both fuel costs and non-fuel costs came in slightly lower than expected, boosting Delta's operating margin to 12.6%, ahead of the 11.5%-12.5% guidance it had provided in December.
The net result for Delta was Q4 adjusted EPS of $0.78: just above the average analyst estimate of $0.77. On a GAAP basis, Delta actually lost more than $700 million last quarter. However, this figure is misleading because it includes a $2 billion writedown for the value of fuel hedges that will settle in 2015.
The $2 billion of hedging losses related to 2015 will be offset by vastly lower market prices for jet fuel this year. Delta's adjusted earnings results are more meaningful because they include only the hedging losses (or gains) settling in a particular quarter. In other words, the $2 billion of hedging losses will gradually filter through Delta's adjusted results over the course of 2015.
Looking ahead to even bigger profits in 2015
Based on the current price of jet fuel, Delta expects to save $2 billion on fuel in 2015, despite its significant hedging losses. That's even bigger than the $1.7 billion net benefit that Delta had estimated at its Investor Day -- no doubt because oil prices have fallen even further since then.
This will drive strong earnings growth. For the March quarter, Delta expects its adjusted operating margin to reach 11%-13%, up from about 7% last year. This margin growth can be wholly attributed to "all-in" fuel costs that will be more than $0.50 per gallon cheaper than the $3.03 per gallon that Delta paid in Q1 2014.
This means Delta expects little or no growth in unit revenue this quarter (similar to the 0.8% increase it achieved last quarter). However, that's not a bad result in a falling fuel price environment. If Delta can just keep unit revenue roughly stable this year, its pre-tax income could surge to about $6 billion.
Due to Delta's careful management of capital expenditures, its strong earnings performance will also lead to record free cash flow this year, potentially reaching $5 billion. This will allow it to increase its dividend and buy back a lot of stock while still reducing debt and reducing its pension funding deficit.
In short, Delta performed well last quarter and is on track for another year of record earnings in 2015. While Delta shares rose before the market opened on Tuesday, there is plenty of upside left for long-term investors.