American Airlines Group, Inc. (NASDAQ:AAL) reported a massive jump in Q1 earnings last Friday. Adjusted profit tripled year over year to $1.2 billion, even as revenue declined 1.7%. The tailwind of low fuel prices is allowing American to easily overcome the other headwinds it faces.
American's top leaders spent about an hour talking to analysts and the media about the company's results and outlook on Friday morning. Here are five of the main points they tried to emphasize.
Reaping the benefit of cheap oil
Using the April 21 fuel curve, we are forecasting our 2015 consolidated fuel price to be in the range of $1.89 to $1.94 per gallon ... Based on these prices, we expect our 2015 consolidated fuel expense to improve by approximately $4.35 billion year over year.
-- CFO Derek Kerr
In 2014, American Airlines earned a record adjusted profit of $4.2 billion. For 2014, American's management expects the benefit from lower fuel prices alone -- $4.35 billion -- to be bigger than the company's entire (record) profit from last year!
Some of these fuel savings are being offset by cost increases related to new labor contracts. American also needs to offset the impact of the strong dollar and weak demand in Brazil and Venezuela. Nevertheless, the magnitude of American Airlines' fuel savings is so great that it will produce strong margin expansion this year despite these other cost and revenue headwinds.
Moderating growth plans
...[W]e lowered full-year overall system capacity guidance by 0.5 point and are now forecasting it to up approximately 2%.
American Airlines posted a modest decline in passenger unit revenue of 1.7% last quarter. It is projecting a sharper 4%-6% decline in Q2 as key headwinds like the strong dollar, falling fuel surcharges, and rising competitive capacity worsen.
So far, American's profitability remains intact, but the management team isn't resting on its laurels. In fact, the company has cut its capacity outlook for four straight quarters as international demand growth has softened. American also went a step further last week by deferring the delivery of five Dreamliners scheduled to arrive next year until 2017 and 2018. This will reduce its international capacity growth next year.
Integration work is on track
We've made some significant progress this year on integration. And some of the recent integration highlights ... included our pilots ratif[ying] a new five-year contract. We received our single operating certificate from the FAA on the very day and schedule that we originally planned a year and a half ago. We successfully ... combined into a single frequent flier program. And we rebanked both the DFW and Chicago hubs ...
-- President Scott Kirby
One of the biggest risks for American Airlines investors right now is the ongoing process of integrating American and US Airways. Many promising airline mergers in the past have hit big snags in the course of the integration process.
So far, everything is going according to plan. American Airlines completed one big integration task about a month ago: merging the two frequent flier programs. However, the biggest integration item -- merging the American Airlines and US Airways reservations systems -- won't occur until late 2015. If that goes smoothly, the merged company should be in the clear.
More merger synergies coming
...[S]ome of the big [synergies] won't come until after we get to a single reservation system. Some of the biggest things are the connectivity of the network, moving aircraft around, regauging the airline and putting the right sized aircraft in the optimal market.
While that reservation system integration comes with a lot of risk, the eventual rewards will be significant. First of all, it will allow American Airlines to better allocate its aircraft across airports and routes in order to match capacity and demand.
Second, by managing the entire business as a single airline, American should be able to fine-tune its revenue management operations. This should ultimately help the company to offset the recent revenue headwinds and return to unit revenue growth next year.
No plans for major debt reduction
So our view is that the best thing for our shareholders is not to go try and target any particular debt-to-equity ratio or target rating. ... [G]iven that we can borrow at the rates we are borrowing ... we think the right thing to do is to ... borrow as much as we can.
-- CEO Doug Parker
Many U.S. airlines have been focused on using their rising earnings and cash flow to reduce their debt levels. Delta Air Lines has been particularly aggressive in this regard, having paid down nearly $10 billion of debt in the past five years.
Investors shouldn't expect American to follow that course, at least for the time being. While the company is opportunistically prepaying some high-cost debt, Parker argued that it doesn't make sense to pursue debt reduction when interest rates are at historic lows. Recently, American Airlines has arranged aircraft financing with sub-4% interest rates.
Ultimately, this means that American may ramp up its share repurchases after it completes the merger integration process. The company has a lot of excess cash on its books. If it isn't going to be used for paying down debt, buying back stock is the most logical alternative.