American Airlines Group (NASDAQ:AAL) reported record fourth-quarter and full-year earnings on Tuesday. American Airlines shares fell, though, weighed down by the company's forecast that unit revenue will decline again this quarter.
Following the earnings report, American Airlines executives held an hour-long conference call with financial analysts and the media to discuss the results and outlook for 2015. Here are five key points they emphasized.
Big fuel savings coming in 2015
As I mentioned earlier, we are seeing substantial financial benefit as a result of the recent drop in crude oil prices.... [W]e are forecasting our 2015 consolidated fuel price to be in the range of $1.73 to $1.78 per gallon. Based on these prices we expect our 2015 consolidated fuel expense to improve by more than $5 billion year-over-year. -- American Airlines CFO Derek Kerr
American Airlines is benefiting tremendously from its controversial no-hedging policy. With oil prices having collapsed since September, many airlines are seeing their fuel cost savings limited by hedging losses. That's not a problem for American.
As a result, American Airlines expects to pay an average of $1.73-$1.78 gallon for jet fuel this year. That compares to an average price of $2.91 in 2014. The resulting $5 billion (or more) of fuel cost savings will ensure that American Airlines soars to another year of record earnings in 2015, despite some of the other headwinds it is facing.
Unit revenue under pressure for now
As I said earlier, we saw some large competitive capacity growth in AA markets during the fourth quarter. In the first quarter we have new competition in five more markets, but we will still feel the impact of the 50 new markets that started in the fourth quarter. Including all of the effects described above, we expect system PRASM [passenger revenue per available seat mile] to be down 2% to 4% in the first quarter. -- American Airlines President Scott Kirby
The biggest headwind impacting American Airlines right now is supply demand imbalance in a number of its markets. In October, American's management stated that Southwest Airlines' expansion in Dallas and Washington, D.C. -- both key hubs for American Airlines -- wouldn't impact unit revenue. Now they realize this forecast was too optimistic.
While American Airlines is seeing strong travel domestic demand, a significant increase in supply almost always drives prices lower. This has particularly affected point-to-point travel in the Dallas-Fort Worth area. American Airlines is also facing currency-related revenue pressure on many international routes, especially to Brazil and Argentina.
These revenue headwinds should ease in the next quarter or two. American Airlines is rebanking its Dallas-Fort Worth hub to bring in connecting traffic that Southwest Airlines isn't targeting. Revenue comparisons on international routes will also get much easier as the year progresses. Thus, American's projected 2%-4% Q1 unit revenue decline should be the worst decline of the year.
Capacity plans are fairly rigid
There has been a lot of talk of capacity changes in response to lower fuel prices. You won't see any changes from us in the near future since we continue to run the airline as though high fuel prices will return. Even if we were inclined to be less disciplined about expansion, our infrastructure is not set up to handle additional capacity increases above our current plans for at least 18 to 24 months. -- Derek Kerr
One of the biggest worries for some airline investors has been that airlines will fritter away their fuel cost savings by expanding so much that an oversupply of capacity will drive down fares. American Airlines management made it clear on Tuesday that it is more inclined to cut capacity for 2015 than increase it.
Moreover, CFO Derek Kerr pointed out that limited training infrastructure is a major barrier to faster growth. American Airlines itself would need to add flight simulators and train new flight instructors to ramp up its growth. Other airlines face similar constraints (as well as a growing pilot shortage) that will keep industry capacity growth at reasonable levels.
Big integration milestones coming
2015 is going to be a key year for our integration; getting to a single operating certificate; merging into single frequent-flier programs; integrating our reservation system; achieving joint collective bargaining agreements with our remaining workgroups -- all those things need to be done in 2015 and our goal is to accomplish all of those in the year. -- American Airlines CEO Doug Parker
2015 will be the critical year for American Airlines' integration efforts. The company is nearing the end of the process of merging the American Airlines and US Airways operating certificates. That's a major step toward operating as a single airline. Reaching joint collective bargaining agreements with all employee unions will complete that process.
From a customer perspective, the most noticeable change will be that the AAdvantage and Dividend Miles frequent flier programs will be merged in Q2. However, the most important milestone will be the switch to a single reservation system.
Moving to a single reservation system will allow American Airlines to better optimize its fares to maximize unit revenue. The switchover will be tricky, though -- in numerous airline mergers, this issue has caused major technology and customer service snafus. United Continental is just starting to recover from a botched reservation system integration that occurred nearly three years ago.
Reducing the share count
As a result of these share repurchases... the Company's fully diluted share count has been reduced from 756 million at the time of merger close to 719 million today for a reduction of approximately 5%. The Company's Board of Directors... also authorized an additional 2 billion share repurchase program to be completed by the end of 2016. -- Derek Kerr
American Airlines has invested heavily in new aircraft recently. Because of its rising profitability, it has been able to simultaneously return some cash to investors. Through various means, including a $1 billion share repurchase, the payment of some employee stock compensation in cash, and the retirement of convertible debt, American has reduced its share count by almost 5% since late 2013.
On Tuesday, American Airlines announced a new $2 billion repurchase program. This should allow it to reduce the share count by another 5% by the end of next year. A few years from now, the merger will be complete, and American Airlines will have finished most of its fleet renewal project, reducing its CapEx burden. Then, it should be able to dramatically increase its capital returns for investors.
As long as American Airlines doesn't get tripped by any of the integration hurdles it faces this year, it will be well-positioned for solid profitability and rising cash flow in the next few years. Long-term investors will be able to reap the rewards.