Delta Shows Solid Operating Performance Even As Special Charges Clip Its Profit

Delta Air Lines (NYSE:DAL) reported solid core operating results in the third quarter with strong top line growth and margin expansion. The carrier’s top line rose by 7% annually to $11.2 billion as it expanded flying capacity on domestic and Latin international routes. Gains from cost cuts, which Delta initiated about two years back, helped expand its operating margin to 15.8%, resulting in third quarter profit of nearly $1 billion, excluding special charges.

However, on a GAAP basis, which includes special one-time charges, Delta’s third quarter profit shrank to $357 million, from nearly $1.4 billion in the year-ago period. ^[1] The company’s results were impacted by primarily one-time charges resulting from the accelerated retirement of its 747 fleet. However, as these charges are one-time in nature, we figure the company’s future results are better indicated by its core operating results, which were solid in the third quarter.

Separately, Delta CEO Richard Anderson said that the carrier is not seeing any impact on its advance booking rates from Ebola. Recently, after a second nurse who cared for the Liberian Ebola-infected man was diagnosed with the disease, concerns about the spread of this disease mounted in the U.S.. Many airline stocks including Delta fell sharply at the time, reflecting these concerns. Investors and traders feared that many people could shelve their travel plans around the holiday season, which is a peak travel period for airlines. However, Delta put those concerns to rest in its third quarter earnings announcement saying that it has not seen any impact on its advance booking rates. On the contrary, the carrier said that it is anticipating a record fourth quarter with solid top line growth and margin expansion.

We currently have a stock price estimate of $39.25 for Delta, about 15% ahead of its current market price. We are in the process of incorporating the third quarter results and shall update our analysis shortly.

See our complete analysis of Delta here

Third Quarter Top Line Rose On Capacity Expansion

Delta expanded its flying capacity by 3% annually in the third quarter, focusing on domestic and Latin international markets. With the demand for flights remaining solid in these markets, the carrier’s higher flying capacity was well absorbed and its third quarter passenger traffic rose by 4% annually. Driven by this higher passenger traffic, Delta’s overall passenger revenue rose by 6% annually to $9.8 billion in the third quarter. Separately, Delta’s cargo revenue also rose to $244 million in the third quarter after steadily falling for many past quarters. ^[1] This recovery in cargo revenue could be indicative of a steady recovery in global cargo markets, and we could see some tailwind from cargo revenue in Delta’s results in the coming quarters.

Gains From Cost Cuts Ensure Strong Operating Margin

On the margin front, Delta was able to expand its operating margin to an impressive 15.8% in the third quarter. For a fifth consecutive quarter, the carrier was able to control growth in its non-fuel CASM at under 2%, when measured on a year-over-year basis. Non-fuel CASM (cost per available seat mile) is a standard metric used in the airline industry to measure an airline’s cost efficiency. Fuel costs are excluded from this metric to more accurately assess how well an airline manages the costs it can control. We figure the cost cutbacks that Delta initiated two years back are helping control its non-fuel costs. Those cost initiatives, some of which are ongoing, focused on restructuring the carrier’s domestic fleet and enhancing its employee productivity. Delta anticipates that gains from these measures will keep growth in its non-fuel CASM at under 2% in the fourth quarter as well. On this basis, the carrier has forecast its fourth quarter operating margin to be around 10-12% – a quarter in which operating margins of airlines remain under pressure due to additional costs imposed by the onset of winter. ^[1]

Outlook For The Fourth Quarter

All in all, Delta posted a solid third quarter, and it looks set to carry forward this momentum in the fourth quarter. The carrier plans to increase its flying capacity by 3% annually in the fourth quarter as well, and we figure with the demand environment likely to hold steady, this capacity increase will help grow the carrier’s passenger traffic and top line. Healthy operating margin will ensure that this top line growth gets translated into a strong fourth quarter bottom line.

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1. Delta’s 2014 Q3 earnings form 8-K, October 16 2014, www.delta.com [↩] [↩] [↩]