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Investment Overview for Delta Air Lines (NYSE:DAL)
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Below are key drivers of Delta Air Lines value that present opportunities for upside or downside to the current Trefis price estimate.
Delta - US
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Fuel Expense % Revenue for Delta's US flights: We expect fuel expenses to make up for 39.2% of revenues for Delta's US flights by the end of the Trefis forecast period. If however the fuel costs as a percentage of passenger revenues decline to 38% by the end of the Trefis forecast period driven by sustained weakness in the global economy then there could be a potential upside of approximately 10% to the current ${trefisprice}.
- US Passenger Revenue per Revenue Passenger Mile: Delta’s US Passenger Revenue per Revenue Passenger Mile increased from $0.119 in 2009 to $0.154 in 2012. We expect it to increase because of increasing fuel prices, eventually reaching $0.189 by the end of the Trefis forecast period. Due to stiff price competition, airlines increase fares as a last resort when no further cost increases can be absorbed. If however, airlines increase airfares more liberally or on account of larger than expected rise in fuel prices, and the revenue per revenue passenger mile rises to $0.21 by the end of our forecast period, then there could be a potential upside of approximately 10% to the current Trefis price estimate.
Delta - International
- International Passenger Revenue per Revenue Passenger Mile: Delta’s International Passenger Revenue per Revenue Passenger Mile has increased from $0.106 in 2009 to $0.143 in 2012. We expect it to continue to increase reaching $0.174 by the end of the Trefis forecast period. If this figure increases to $0.194 instead, there could be a potential upside of nearly 10% to the current Trefis price estimate. If however, due to competitive pressure, the figure increases to only $0.16 by the end of the Trefis forecast period, then there can be a potential downside of nearly 10% to the current Trefis price estimate.
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Delta Air Lines is one of the largest passenger airlines in the world by available seat miles operating under a single certificate. It is headquartered in Atlanta and operates an extensive domestic and international network, spanning North America, South America, Europe, Asia, Africa, the Middle East, the Caribbean and Australia. Delta and its subsidiary Delta Connection operate over 4,000 flights every day.
Delta's route network is centered around the hub system it operates at airports in Amsterdam, Atlanta, Cincinnati, Detroit, Memphis, Minneapolis-St. Paul, New York-JFK, Paris-Charles de Gaulle, Salt Lake City and Tokyo-Narita. Each of these hub operations includes flights that gather and distribute traffic from markets in the geographic region surrounding the hub to domestic and international cities and to other hubs. Delta's network is supported by a fleet of aircraft's that is varied in terms of size and capabilities, giving it the flexibility to meet corporate demands for travel.
It also has bilateral and multilateral alliances with foreign airlines to improve access to international markets. These arrangements include code sharing, reciprocal frequent flier program benefits, shared or reciprocal access to passenger lounges, joint promotions, and common use of airport gates among others. Delta's international code sharing agreements enable it to market and sell seats to an expanded number of international destinations.
Delta has international code share agreements with Aeromexico, Air France, Air Nigeria, Avianca, China Airlines, China Southern, CSA Czech Airlines, KLM Royal Dutch Airlines, Korean Air, Olympic Air, Royal Air Maroc, VRG (and some affiliated carriers operating in conjunction with some of these airlines).
It has alliances with various airlines, including membership in the SkyTeam, a global airline alliance. Delta also has a transatlantic joint venture with Air France-KLM and Alitalia. It has a domestic marketing alliance with Alaska Airlines which enables it to expand services in the west coast. The company also has agreements with domestic regional carriers, which operate as Delta Connection.
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The US segment is more valuable to the company than the international segment because of the following reasons.
Higher amount of Available Seat Miles (ASM) in the US
Delta has higher amount of ASM capacity in the United States compared to the international routes it operates in. Available Seat Miles in the US in 2011 were about 12% higher than those available on international routes, which also supports a higher percentage share on domestic routes than on the international circuit.
Higher occupancy rate in domestic flights
Delta's US operations have historically had on average 2-3% more occupancy than its international segment. In the airlines business a higher occupancy rate has a very high impact on the revenues and profitability of a division. Benefiting from sustained capacity efficiencies and increasing corporate share in key domestic business markets, Delta's US operations are expected to have a higher occupancy rate than its international operations.
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Oil prices significantly impact Delta's bottom line
Fuel expenses represent one of the largest single costs faced by airliners and account for over 30% of the costs for airlines. John Heimich, chief economist the Air Transport Association (ATA), recently said that every penny increase in the cost of jet fuel makes a $175 million difference towards the airlines bottom line.
According to a company presentation, a 1 cent change in the price of fuel equates to $40 million of annual fuel expense for Delta. A focus on keeping prices competitive in the airline industry prevents Delta from immediately passing on fuel price increases to its customers, so Delta's expenses are heavily impacted by fuel prices and their volatility.
Weak macroeconomic conditions
The main challenge the global airline industry faces is the state of the global economy. Europe’s sovereign debt crisis has created enormous uncertainty and is impacting the overall profitability of the sector.
Cautious capacity stance
Due to rising fuel expenses and weak economic conditions, several airlines have been forced to cut back on routes. Capacity cuts impact the top line but help costs by way of higher load factors. We anticipate airlines to maintain a cautious capacity stance till the global economic environment improves.
Growth in ancillary revenues
With profitability declining for the overall airline sector, many of the carriers are figuring out ways to improve income by increasing ancillary forms of revenues. Baggage fees have been one of the main drivers of profitability for many airlines. Airlines are adding various new features to help boost revenues such as WiFi, in-flight entertainment, and improvements in lounge facilities.
According to a recent Amadeus/IdeaWorks study, North American airlines collectively produce one of the largest stream of ancillary revenues compared to other regions. A majority of the increase is attributable to stronger merchandising efforts by the carriers as well as addition of more à la carte services for sale.
Delta currently makes about $200 million in merchandising revenues and is targeting to grow to $1 billion by 2013 through expanded product offerings such as extra leg room, preferred seating, hotel, car rentals and trip insurance. The study also revealed that around 50% of ancillary revenues for the U.S. airlines is generated by the sale of frequent flier miles, notably those linked to co-branded credit card activity.
Unionized labor agreements
The airline sector has historically been extremely labor intensive. Over the past several years many people lost their jobs and experienced cuts in their benefits as airlines struggled with rising fuel prices and weak economic conditions. The model is now changing and expected to change for good to ensure that airlines are not overburdened with liabilities they cannot afford. Jet Blue, for instance, offers no pension to its workers and employees are expected to pay a portion of their healthcare costs. Several airlines are transitioning to similar models. United Airlines at one time used to fully cover its employees healthcare costs, but now workers are paying about 25% of that cost.
Another similar example is of Delta which has decided to change to a defined contribution plan for new employees. Rather than additional contributions made by the carrier to provide a fixed amount of money at retirement, the new model is based on the contribution by Delta right now and employees must rely on the rate of return then realized. Employees are also required to manage their own assets in this plan.
Airline consolidations and joint ventures
In recent times, airlines have gone through a period of mergers and consolidations to combat rising costs and realizing efficiencies as well as to chart out a path for future growth and profitability. Recent mergers and consolidations include the United Airlines merger with Continental in 2010, Southwest’s acquisition of Airtran in 2011, and British Airways merger with Iberia in 2011 which led to the creation of the International Airlines Group (IAG).
Apart from mergers, several airlines have undergone joint ventures with each other. These alliances provide many of the same benefits of a merger but involve significantly lower expenses and thus make it a viable option for many carriers. Some of the notable joint ventures in 2011 include, American Airlines and Japan Airlines transpacific joint venture as well as the Qantas and British Airways joint venture to provide services between the U.K. and Australia.
It is very likely that several mergers will occur in the near future to bring about cost efficiencies and increase route coverage. The impact of these joint ventures however, has been an increase in average ticket prices for individuals and corporate clients.
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How do we get the historical numbers for this chart?
Trefis has a team of in-house Analysts who gather historical data from company filings and other verifiable sources. When historicals are available, we explain how we got them at the bottom of the Trefis analysis section below.
Who came up with the Trefis forecast for future years?
The Trefis team of in-house Analysts considers a variety of factors when projecting any forecast. The rationale for our projections is explained in the Trefis analysis section below.
How does my dragging the trendline on the chart impact the stock price?
- We use forecasts for business drivers to calculate forecasted Revenues and Profits for each division of the company.
- We then use forecasted Profits in a Discounted Cash Flow (DCF) model to obtain the Price Estimate for the company.
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