MIAMI — American Airlines reported a record $597 million net profit for the quarter of 2014, taking full advantage of the precipitous drop in fuel prices due to its lack of fuel hedges. Excluding special items, primarily costs related to the ongoing merger integration between American and US Airways, the net profit for the quarter (Q4) was $1.1 billion, up 153% year-over-year (YOY). For calendar 2014, American’s net profit excluding special items came in at $4.2 billion, up 115% YOY, while including special charges, full year profit reached $2.9 billion.
Lots of ink has been spilled about American’s (smart) decision not to hedge on fuel prices, and that decision certainly paid off, to the tune of $555 million in fuel expense savings, and million of dollars worth of mark-to-market losses that American will never have to suffer. There’s not much to say except that Chairman and CEO Doug Parker and his management team made a bet on the basis of their convictions, and that bet paid off handsomely.
In 2015, American expects the savings from lower oil prices to total $5 billion. That’s $5 billion worth of contribution to American’s bottom line, which if valued at American’s trailing 12 months price to earnings ratio of 13.11, is worth an estimated $65.6 billion in market capitalization. By comparison, American’s current market cap is just $36.5 billion, so the reduction in fuel price (theoretically) triples American’s value. If nothing else, this is illustrative of just how much at the mercy of fuel prices the airline industry is.
But whereas the fuel costs are the positive side of the American Airlines story, revenues, specifically unit revenues (passenger revenue per available seat mile or PRASM) disappointed, declining 1 percent year over year. Adjusted for stage length, the decline was not so sharp, but when combined with guidance for a 2-4 percent decline in PRASM in the first quarter of 2015, it is clear that American faces some revenue headwinds.
The primary culprit is Latin America, where PRASM declined an alarming 11.3 percent YOY as yields fell 8.6 percent and demand itself cratered sharply. Venezuela of course is the primary worry, with $656 million of American’s money still trapped in the country. But Argentina very quietly is a financial basket case under the socialist government of President Cristina Kirchner, which has affected premium cabin demand from Buenos Aires. Brazilian macroeconomic conditions are starting to deteriorate, and even in the other, better-run countries on the continent, the decline in commodity prices is sapping demand. Latin America is a significant headwind for the company, and one that must be monitored in 2015.
Other Highlights During the Quarter and the Year Were:
- Hired 7,000 new employees, plus 4 percent pay increase for front-line employees;
- Prepaid pension obligations by $600 million in 2014;
- Added 132 aircraft to fleet and retired 111 older aircraft in 2014, with a plan to add 128 new aircraft and retire 126 in 2015;
- Additional $2 billion share repurchase to be finished by the end of 2016;
- Running American as though operating with $100/barrel oil price;
- Parked eight Embraer ERJ-140s in the fourth quarter;
- Expected first quarter pretax margins of 13-15 percent;
- $2.1 billion of debt repayments in 2015;
- All 221 Boeing 737-800s reconfigured from 150 to 160 seats;
- Combined operation generated double-digit PRASM growth in New York City;
- Capacity reduced 8 percent across the Atlantic and 7 percent to Latin America;
- Re-banking revenues will accrue in Dallas and Chicago in the second quarter, and revenue synergies will jump after a single reservation system in the fourth quarter of 2015;
- Capacity downside can be managed by accelerating retirements – 2015 capacity is down 0.5 percentage points already since last quarter’s guidance;
- Europe is 50/50 point of sale (U.S. vs. Europe), China is mostly U.S. point of sale, deep South America is 70 percent on the Latin end, and the Caribbean and Mexico are mostly U.S. point of sale;
- Energy-related businesses are less than 1 percent of corporate account revenue for American;
- The 737s with 10 extra seats are PRASM dilutive, but margin positive. The extra seats generate 65 percent as much PRASM as the existing 150 seats, but the marginal costs are lower;
- Local yields in Dallas have declined, but connecting RASM has offset some of the decline, but March 29th rebanking will help some more; and
- All Asian routes are expected to be profitable in 2015, new service from Dallas to Asia is largely completed but American is planning expansion out of Los Angeles.
I’d like to start by pointing out that as a shareholder, while this may seem heretical, my actual preference is to see American de-leverage some more and pay off additional aircraft debt. Share repurchases are fantastic, and lord knows they have done some good for the health of my portfolio.
At the same time, share buybacks can sometimes be a poor use of cash, especially when you have a higher burn rate on capital expenditures. I’ll trade the long run improvement in American’s finances after paying down debt or pension obligations for the short term gain of an extra 5-6 percent. This is one case where the traditional Wall Street mentality is hurting the company.
On a brighter note, I do have some positive news regarding the state of American’s labor relations. According to sources within the company, several employee groups were spooked by the contract pathway taken by the flight attendants. Accordingly, our source informs us that each of the employee groups is likely to ratify an agreed-upon contract without arbitration, most notably the pilots, whom our source expects to narrowly pass the agreement later this week. From the pilots’ perspective, work rules aren’t going to change substantially under arbitration, but they will be about $600 million poorer if they vote down this contract.
Regardless, American’s management of its labor relations has been about as good as one could hope sans Southwest or Delta levels of employee mythology. It speaks to the incredible competence of this management team, which is fast challenging Richard Anderson and company at Delta for the best in the business. I believe in this management team, to the point that I’ve staked an (admittedly minor) portion of my personal wealth on its success. And as (the new?) American Airlines enters what is set to be another year of record profitability, it will be exciting to see where American’s initiatives end up.