Virgin America, (NASDAQ:VA) completed its IPO last November, and on Wednesday it released its first earnings report since going public. The results were solid.
Virgin America reported Q4 adjusted EPS of $1.18, or $0.71 on a pro forma basis that treats the company as if it had gone public at the beginning of the quarter. Excluding special items, Virgin America's net income nearly doubled year over year, driven by strong ancillary revenue growth, lower fuel prices, and lower interest expense.
With fuel prices remaining low, Virgin America is on track for another year of margin expansion in 2015. This will put it in good position to begin growing at a faster pace later this year and in 2016.
Solid demand trends
Many airlines have observed a drop-off in unit revenue recently, due to overcapacity in certain markets, the lower cost of jet fuel, and (for airlines with global route networks) the strong U.S. dollar. So far, Virgin America has been able to buck these trends.
In Q4, Virgin America's passenger unit revenue rose 1.5% year over year. Total unit revenue -- which includes ancillary revenue from sources like bag fees and selling frequent flier miles -- rose 3.7%. Passenger unit revenue is likely to be flat in Q1, but total unit revenue could still grow modestly thanks to continuing ancillary revenue momentum.
In any case, this guidance is better than what many of Virgin America's competitors have projected. The guidance is also impressive insofar as capacity increases by JetBlue Airways on transcontinental routes have created pricing pressure on some of Virgin America's core routes.
Good cost control (for now)
Virgin America expects non-fuel unit costs to rise 1%-3% during Q1. However, this will be more than offset by a sharp drop in fuel expense. Last year, Virgin America's Q1 economic fuel expense was $3.16 per gallon, and fuel represented more than 35% of the company's operating expenses. By contrast, Virgin America expects to pay $2.45-$2.55 per gallon for fuel in Q1 2015.
Virgin America's interest expense will also drop significantly this year, as the company paid off most of its debt in connection with its IPO. In Q1 2014, Virgin America's "other expense" line item -- which mainly counts interest expense -- totaled $9.2 million. At its current debt level, Virgin America will only spend $2.5 million per quarter on interest.
Non-fuel cost creep will increase after Q1, because Virgin America is giving its employees big raises in April. (For pilots, the increase will average 15%.) As a result, for the full year, non-fuel unit costs are expected to increase 4%-6% before the impact of profit sharing.
That said, as long as oil prices don't rise too much, Virgin America's fuel cost savings will far outweigh its non-fuel cost growth. Additionally, Virgin America has reduced its potential profit-sharing costs by implementing a pre-tax income threshold for profit sharing (approximately $81 million in 2015). Employees will only accrue profit sharing on company income beyond that threshold.
Getting ready for growth
As long as unit revenue continues to hold up well and fuel prices stay relatively low, Virgin America's profit margin should expand by several points this year. This will put it on a stable financial footing to resume a faster growth pace later this year and in 2016 (as planned).
Virgin America's first growth priority is to fill out its schedule at Love Field in Dallas, where it won the rights to two gates last year. In late April, it will begin flying five times daily from Dallas to Austin. The company hopes to take advantage of strong demand from travelers who currently drive but would prefer to fly at a reasonable price.
By the fall, Virgin America expects to have fully filled out its Dallas flight schedule. At that point, it will fly four times daily from Dallas to five different cities: San Francisco, Los Angeles, New York, Washington, D.C., and Austin.
Another priority for later this year and 2016 is launching service to Hawaii. Virgin America is likely to start with flights from its main base in San Francisco, but it is also interested in flying to Hawaii from its focus city of Los Angeles.
Beyond those two objectives that Virgin America has spelled out, the carrier is likely to start filling in some of the major gaps in its route network. Today, it only flies to a handful of U.S. metro areas beyond the West Coast. Due to its business travel focus, Virgin America ultimately needs to fly to most of the big metro areas, though.
It will take time to develop a more comprehensive route network. But based on its success in competing with the legacy carriers for business traffic thus far, it would be foolish to bet against Virgin America in the long run.