On Friday morning, American Airlines Group, Inc. (NASDAQ:AAL) reported another record profit, as it has in every quarter since it merged with US Airways in late 2013.
As was the case in the final quarter of 2014, investors can thank low oil prices and the prescient no-hedging strategy adopted by American Airlines CEO Doug Parker and the rest of his management team for the company's strong earnings growth. Lower fuel prices will continue to be a huge tailwind through the rest of 2015. This should keep American's earnings at record levels despite some other headwinds that it faces.
The hard numbers
For Q1, while American's revenue fell 1.7% to $9.8 billion, adjusted net income roughly tripled from $402 million last year to $1.2 billion this year. Adjusted EPS came in at $1.73, which just barely beat the average analyst estimate of $1.71.
Unit revenue including ancillary revenue, or RASM, declined by 0.7% last quarter, while unit revenue excluding ancillary revenue, or PRASM, declined by 1.7% on a 0.9% capacity decrease. American's PRASM was pressured by the strong dollar, economic weakness in some international markets, and competitive capacity growth on numerous key routes.
American's cost per available seat mile fell 10.8% excluding special items, thanks to a big drop in fuel costs. Excluding fuel and special items, unit costs rose 5.2%, largely due to the impact of new labor contracts -- particularly for pilots.
American Airlines posted a pre-tax margin of 12.7%, in line with its updated guidance from early April projecting a 12%-13% pre-tax margin. However, this was slightly below American's original pre-tax margin guidance of 13%-15%. Nevertheless, this was a remarkable result considering that Q1 is seasonally the weakest quarter of the year.
Capitalizing on cheap oil
The key driver of American's improved profitability was the massive drop in oil prices that has occurred since mid-2014. In Q1 2014, American Airlines paid an average of $3.10 per gallon for jet fuel. By comparison, it paid just $1.83 per gallon for jet fuel last quarter: a 41% decrease.
Since American uses more than 1 billion gallons of jet fuel per quarter, this drop corresponded to fuel cost savings of nearly $1.3 billion.
Still lagging Delta
American Airlines' management team deserves a lot of credit for its decision not to hedge fuel costs. That said, it's interesting to note that American's profit of $1.2 billion was slightly smaller than its fuel cost reduction of $1.3 billion.
By contrast, Delta Air Lines (NYSE:DAL) got caught on the wrong side of some fuel hedging bets last quarter. But even as hedging losses of $1.1 billion wiped out nearly all of Delta's fuel cost savings, Delta still increased its Q1 EPS from $0.33 to $0.45 thanks to its solid non-fuel cost control and ancillary revenue growth.
A similar dynamic is likely to play out in Q2. Delta recently projected that PRASM will decline 2%-4% in Q2. American Airlines expects a larger 4%-6% decline in that same metric. Delta will also probably benefit from smaller non-fuel unit cost increases and better ancillary revenue trends.
However, Delta will again be hit by big fuel hedging losses, while American will enjoy the full benefit of lower oil prices. As a result, American is projecting a pre-tax profit margin that is several percentage points better than Delta's margin guidance.
In the second half of the year, Delta expects its fuel hedging losses to subside dramatically. But American Airlines will also benefit later this year from easier revenue comparisons and new efforts like the rebanking of its Chicago and Dallas-Fort Worth hubs.
It will be interesting to see whether American can maintain its margin advantage over Delta after its fuel cost advantage narrows later in 2015. At the moment, it looks like American needs to make more merger integration progress if it wants to have the highest profit margin among the legacy carriers beyond Q2.
Adam Levine-Weinberg is long January 2017 $40 calls on Delta Air Lines, The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.