3 Airlines That Could Soar With Lower Oil Prices

Last week, OPEC once again failed to reach any agreement on reining in production to stabilize oil prices. The group didn't even attempt to set a production quota -- not that it would have mattered, since OPEC has been routinely exceeding its collective production target of 30 million barrels per day this year.

This development makes it look like oil prices will go even lower and could stay depressed for even longer than previously expected. January Brent crude futures fell below $41 a barrel on Monday, down from over $100 in mid-2014. Some pundits think oil prices could go as low as $20 a barrel.

The world's largest airline would be a big beneficiary of lower oil prices. Photo: American Airlines.

Cheap oil has been a big boon for airlines in 2015. If oil remains cheap going forward, American Airlines , Virgin America , and Spirit Airlines will be three of the biggest beneficiaries.

The biggest airline bets on cheap oilAmerican Airlines' management team made a wise decision years ago to avoid fuel hedging. This decision allowed the company to reap the full benefit of falling oil prices in 2015. Even as the cost of hedging future fuel needs has plummeted since mid-2014, American Airlines has stayed on the sidelines. This move amounts to an implicit bet that fuel prices will remain low for quite a while.

As a result, American Airlines will be one of the biggest beneficiaries of the ongoing oil-price rout. The company expects to pay an average price of $1.70 to $1.75 per gallon for jet fuel in 2015, down from $2.91 a gallon a year earlier.

Based on the current oil futures curve, American could end up paying less than $1.50 a gallon in 2016. That would generate $1 billion or more in year-over-year savings.

American Airlines CEO Doug Parker has warned that ongoing pricing pressure may cause the company's profit margin to shrink in 2016 from the record level reached this year. However, another drop in fuel prices could offset that pressure in whole or in part.

A stable profit margin combined with American's massive share repurchases could lead to significantly better-than-expected earnings per share next year. That situation could snap American Airlines stock out of its funk in a hurry.

The cost of comfort is decliningAnother airline that should be a big beneficiary of lower oil prices is Virgin America. Unlike American Airlines, Virgin America faced significant hedging losses in the first half of 2015, paying an average of $2.32 a gallon for fuel during that period.

Virgin America is likely to face smaller hedging losses as well as an even lower market price for jet fuel in 2016. It will therefore realize significant fuel savings next year.

Virgin America is on pace for more fuel savings in 2016. Photo: Virgin America.

Virgin America is especially sensitive to fuel prices because it doesn't squeeze as many seats onto each plane as most other airlines. It should be no surprise that Spirit Airlines crams about 20% more seats onto its A319s and A320s than Virgin America. But even American Airlines fits a few more seats on its planes.

Offering passengers more space allows Virgin America to earn a revenue premium on many routes. However, it involves a trade-off in fuel efficiency. (That said, the youth of Virgin America's fleet helps offset this disadvantage.) With cheaper jet fuel, Virgin America will face a lower-cost penalty for offering its customers more space.

The fall in jet fuel prices comes at a particularly good time for Virgin America, which plans to ramp up its growth rate into double-digit territory next year. Lower unit costs will allow Virgin America to offer low introductory fares on new routes while remaining quite profitable.

More fuel-funded growth at Spirit AirlinesInvestors haven't been too pleased with Spirit Airlines' performance this year. The stock has lost about half of its value in the past year as the company had to cut its guidance multiple times during the year.

Spirit Airlines had to cut its guidance more than once this year. Photo: Spirit Airlines.

That said, Spirit Airlines expects to increase its pre-tax profit margin from the record level of 19.2% reached last year to a range of 21.5% to 23% in 2015, despite increasing capacity 30% this year. This performance is a remarkable achievement, but it probably wouldn't have happened without the sharp drop in fuel prices.

Spirit Airlines plans to increase its capacity by another 20% next year. This rapid growth will continue to weigh on its unit revenue. But if fuel prices fall again in 2016, Spirit could still produce a stellar pre-tax margin above 20% for the second straight year.

Indeed, Spirit Airlines hopes to grow 15% to 20% annually for the foreseeable future. The longer oil stays cheap, the more it will be able to grow while meeting or exceeding its target margin.

The article 3 Airlines That Could Soar With Lower Oil Prices originally appeared on Fool.com.

Adam Levine-Weinberg owns shares of Spirit Airlines and Virgin America and is long March 2016 $40 calls on Spirit Airlines, long June 2016 $30 calls on Spirit Airlines, and long January 2017 $30 calls on American Airlines Group. The Motley Fool is long January 2017 $35 calls on American Airlines Group. The Motley Fool recommends Spirit Airlines and Virgin America. 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.

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