United and Alaska’s Profits Take-Off On Lower Fuel Expense

United (NYSE:UAL) and Alaska‘s (NYSE:ALK) fourth quarter profits rose sharply as the fall in global crude oil prices slashed jet fuel costs for the carriers. United’s profit, excluding special items, rose over 80% annually to $461 million, while Alaska’s profit rose about 60% annually to $125 million, in the fourth quarter. ^{[1] [2]}

United Continental Holdings

Despite steadily losing market share in the U.S. to low-cost carriers such as Southwest and JetBlue, and smaller carriers like Alaska, United’s profit rose in the fourth quarter. The carrier’s fourth quarter jet fuel expense fell by nearly 15%, or $435 million, lifting its profit single-handedly. ((United’s 2014 Q4 earnings form 8-K, January 22 2015, www.unitedcontinentalholdings.com))

Based on the current low prices of oil, United anticipates its pre-tax margin to be around 5-7% in the first quarter. ^[1] In our view, as oil prices are likely to remain weak for the foreseeable future, United’s profit should grow in the first quarter. These higher profits in turn will enable United to accelerate returns of cash to shareholders, and catch up with other airlines. In 2014, United was able to return $320 million to shareholders through buybacks. ^[1] The carrier currently does not pay dividends due to its high debt load. In comparison, Delta returned $1.35 billion and Southwest nearly $1.1 billion to shareholders through buybacks as well as dividends, in 2014. ^{[3] [4]}

In the current year, United plans to expand its capacity at a modest rate of 1.5-2.5%, from 2014. ^[1] The carrier will concentrate on expanding in Latin and Pacific international markets, as it is facing aggressive expansion from low-cost carriers in the domestic market. We figure United’s moderate rate of capacity expansion will constrain growth in its top line. However, the carrier’s 2015 bottom line will likely grow at a higher rate driven by the decline in jet fuel prices. Fuel expense constitutes nearly a third of United’s total operating cost, so the near 50% drop in crude oil prices since September last year will translate to large fuel cost savings for the carrier this year, accelerating its profit growth.

We currently have a price estimate of $63 for United, around 10% below its current market price.

See our complete analysis of United here

Alaska Air Group

Alaska’s fourth quarter profit growth was driven by not only lower fuel expense but also capacity expansion. In the fourth quarter, Alaska expanded its flying capacity at a high rate of 11% per year. This raised the carrier’s fourth quarter passenger traffic and top line, which grew by 8% annually to $1.3 billion. Lower fuel expense added to this strong top line growth, growing Alaska’s profit by about 60% annually to $125 million. ((Alaska’s 2014 Q4 earnings form 8-K, January 22 0215, www.alaskaworld.com))

Driven by these higher profits and the prospect of sustained weakness in oil prices, Alaska hiked its dividend by 60% to 20 cents a share. ^[2] This stands in stark contrast to United, which despite growing its profits couldn’t initiate dividend payments. Alaska’s debt load is lower, its debt-to-total capitalization stands at a healthy 31%, enabling it to channel higher profits to boosting returns of cash to shareholders. On the other hand, United needs to first pay down its debt before initiating dividends. And the carrier is doing that; it made debt and capital lease payments of $534 million in the fourth quarter and plans to make additional payments of $1.2 billion this year. ^[1] These payments will help lower United’s debt, putting it on a path to start paying dividends in the coming quarters.

Separately, Alaska plans to continue expanding its capacity at a high rate of 8% year-on-year in 2015. Interestingly, Alaska plans to grow its Seattle departures by 10% in 2015, despite the rapid ramp up by Delta in Seattle. ^[2] We figure Alaska is expanding its own network out of Seattle in order to prevent frequent fliers from shifting to Delta. Frequent fliers typically prefer to register with an airline that has a larger network out of their base city. This helps them earn more miles and rewards. Coupled with lower oil prices, Alaska’s aggressive capacity expansion should lift its profit in 2015.

We currently have a price estimate of $60 for Alaska, about 10% below its current market price.

See our complete analysis of Alaska here

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1. United’s 2014 Q4 earnings form 8-K, January 22 2015, www.unitedcontinentalholdings.com [↩] [↩] [↩] [↩] [↩]
2. Alaska’s 2014 Q4 earnings form 8-K, January 22 0215, www.alaskaworld.com [↩] [↩] [↩]
3. Delta’s 2014 Q4 earnings form 8-K, January 20 2015, www.delta.com [↩]
4. Southwest’s 2014 Q4 earnings form 8-K, January 22 2015, www.swamedia.com [↩]