Capacity Expansion & Gains From Cost Cuts Lift Delta’s Results

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Delta Air Lines (NYSE:DAL) reported strong growth in its second quarter results on solid demand for air travel and gains from its own disciplined capacity addition. The carrier’s top line expanded by 9% annually with 4 points of margin expansion in the second quarter. [1] The cost reduction measures that Delta initiated about three years back continued to successfully hold down its non-fuel costs in the second quarter, allowing the carrier to expand its operating margin. Higher margin in turn raised Delta’s second quarter earnings by nearly 18% annually to 94 cents per share. [1] Looking ahead, the carrier anticipates its operating margin to rise further in the September quarter and, in our opinion, Delta looks set to meet its 2014 targets for operating margin, earnings growth and return on invested capital.

We currently have a stock price estimate of $38.17 for Delta, approximately in line with its current market price. We are in the process of incorporating the second quarter earnings and shall update our analysis shortly.

See our complete analysis of Delta here

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Capacity Expansion Drove Growth In Delta’s Second Quarter Top Line

In the second quarter, Delta raised its flying capacity by approximately 3% to take advantage of the growing demand for flights. The carrier hiked its capacity maximum on Latin international routes followed by domestic routes. As a result, the carrier’s overall passenger traffic rose by 5% annually in the second quarter. We figure Delta’s recent investments at Seattle and New York played a key role in helping it expand its second quarter flying capacity and passenger traffic. Coupled with higher unit revenues driven by fare hikes, Delta’s second quarter top line rose by 9% annually to $10.6 billion. ((Delta’s 2014 Q2 earnings form 8-K, July 23 2014, www.delta.com))

Cost Reduction Measures Help Expand Margin

At the same time, the cost reduction measures, including domestic fleet restructuring and maintenance cost management, that Delta initiated three years back helped keep its non-fuel unit costs flat, on a year-over-year basis. Non-fuel unit costs, as measured by non-fuel costs per available seat mile (non-fuel CASM), is a standard metric used in the airline industry to measure an airline’s cost structure and efficiency. Fuel costs are excluded from this metric to more accurately assess how well an airline manages the costs it can control. Fuel costs being linked with the global crude oil prices are out of an airline’s control. In the second quarter, Delta’s non-fuel unit costs remained flat on a year-over-year basis. This is the fourth straight quarter in which Delta was able to keep growth in its non-fuel unit costs under 2%, on a year-over-year basis. The carrier set itself this target of 2% growth in its non-fuel unit costs while it initiated its cost reduction measures three years back.

Gains from strong top line growth and cost reduction measures, expanded Delta’s second quarter operating margin to 14.9%. This was one of the highest operating margin for any U.S. carrier in the second quarter and highlights the financial strength of Delta.

Outlook for The Third Quarter & Full Year 2014

Going forward, Delta anticipates its operating margin to expand further to about 15-17% in the third quarter on continued gains from its cost reduction measures. We figure this margin expansion will help the carrier to continue to post growth in its results. Delta also plans to raise its third quarter flying capacity by 2-3% annually. [1] In our opinion, this rate of capacity addition is disciplined and will likely not impact the overall ability of the airline industry to charge profitable fares from fliers. All in all, with strong performance in the first half, Delta seems on track to achieve its annual targets of 10-15% annual earnings growth, 11-14% annual operating margin and at least 15% return on invested capital.

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Notes:
  1. Delta’s 2014 Q2 earnings form 8-K, July 23 2014, www.delta.com [] [] []