Effective Network Strategy Will Help Delta Maintain Its Growth Momentum

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DAL: Delta Air Lines logo
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Delta Air Lines

Delta Air Lines (NYSE:DAL) has steadily improved its profits over the last few years on gains from cost cutbacks and capacity expansion. The carrier grew its profits from $593 million in 2010 to $2.7 billion last year, and it has continued its impressive profit growth in the first half of this year. [1] Looking ahead, we figure Delta’s effective network strategy revolving around its investment in Virgin Atlantic Airways and its expansion in New York and Seattle, will enable the carrier to maintain its profit growth momentum.

We currently have a stock price estimate of $39.25 for Delta, marginally below its current market price.

See our complete analysis of Delta here

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Cost Reduction Initiatives have Controlled Growth in Delta’s Non-Fuel Costs

About two years back, Delta initiated large scale cost cutbacks in an attempt to limit growth in its non-fuel unit costs, as measured by non-fuel costs per available seat mile (non-fuel CASM). 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 costs it can control. The cost cutbacks that Delta initiated included restructuring its domestic fleet, reducing its employee headcount and enhancing its employee productivity through greater use of technology. These measures helped the carrier bring growth in its non-fuel unit costs to under 2% on a year-over-year basis. Additionally, Delta anticipates to maintain this moderate rate of growth in its non-fuel unit costs for the foreseeable future. [2] So, given this moderate growth in its non-fuel costs, we figure Delta will be able to grow its profits if it is able to grow its top line at a healthy rate.

Delta is Looking to Grow its Top Line Through Network Investments

To grow its top line, Delta is implementing an effective network strategy, which focuses on expanding presence at LaGuardia and John F. Kennedy (JFK) airports in New York and on establishing an international gateway to Asia in Seattle. The carrier is also expanding in the trans-Atlantic market through a joint venture with Virgin Atlantic. Overall, these network investments will help grow Delta’s revenues and profits in the coming years.

Last year, Delta invested $360 million in Virgin Atlantic for a 49% stake in that company. Alongside this investment, Delta and Virgin Atlantic formed a joint venture (JV) covering direct flights between the U.K and North America. Effectively, this JV allows Delta and Virgin Atlantic to undertake joint network planning and scheduling for air travel between North America and the U.K.. This venture also allows the two carriers to coordinate ticket pricing. For Delta, Virgin Atlantic’s slots at the busy Heathrow international airport is the prime attraction, as these slots have enabled Delta to increase its flights between North America and the U.K., including in the lucrative New York-London market. This JV started operations earlier this year, and we figure Delta’s expansion in the trans-Atlantic market as a result of this JV will help grow its results.

Separately, over the last few years, Delta has made significant investments at both LaGuardia and JFK airports in New York. These investments have sought to expand terminals and to construct new gates at both these airports. Effectively, these investments will allow Delta to expand its domestic network out of LaGuardia and its international network out of JFK. Also, with the demand for flights remaining strong in the New York market, Delta’s capacity expansion in this market will help grow its passenger traffic and revenues.

Additionally, Delta is expanding service in Seattle to build the city as its international gateway to Asia. The carrier started 2014 with about 38 daily departures from Seattle, but currently it has expanded that number to around 95 daily departures from this city. [3] Till last year, compared to many other domestic U.S. markets, the Seattle market had less competition with Alaska Air Group enjoying a dominant position. At the same time, growing passenger traffic to Asia from Seattle compelled Delta to build the city as its international gateway to Asia. Additionally, to feed its passenger traffic on international routes, Delta launched domestic service linking Seattle to about a dozen U.S. cities. Effectively, this rapid capacity expansion at Seattle, like the above mentioned network initiatives, will also help Delta grow its passenger traffic and revenues. Subsequently, solid revenue growth driven by these network initiatives will help grow Delta’s profits, as its non-fuel unit costs have been limited by its cost cutbacks.

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Notes:
  1. Delta’s 2013 10-K, February 2014, www.delta.com []
  2. Delta’s presentation at the Deutche bank conference, June 4 2014, www.delta.com []
  3. Alaska analysts on Delta intrusion, July 21 2014, www.thestreet.com []