Lower Fuel Prices Lift Delta’s Net And Outlook

Lower jet fuel prices lifted Delta‘s (NYES:DAL) fourth quarter profit, excluding special items, by 16% per year to $649 million. The airline’s top line also rose by 6% per year to $9.6 billion on capacity expansion. Delta’s full year 2014 profit rose to $2.8 billion, from $2.7 billion in 2013. Looking ahead, with lower fuel prices likely to persist, Delta expects that it could realize $2 billion in fuel cost savings in 2015. ^[1] In our view, such significant cost savings will leave Delta with more cash to pay down its debt and to accelerate returns of cash to shareholders.

We currently have a price estimate of $46.50 for Delta, slightly below its current market price.

See our complete analysis of Delta here

Capacity Expansion, Supported By Rising Demand, Lifts Top Line

In the fourth quarter, Delta expanded its flying capacity by 3.5% annually to take advantage of the solid demand environment, especially in the domestic and Latin international markets. This expansion in capacity was fully absorbed by rising demand, growing Delta’s fourth quarter passenger traffic by 4% per year. ^[2] Higher passenger traffic in turn raised the carrier’s passenger revenue and top line.

Delta’s operating margin also expanded by 400 basis points to 12.6% in the fourth quarter on cost savings from domestic re-fleeting and other cost reduction measures. ^[3] For a sixth consecutive quarter, Delta was able to restrict year-on-year growth in its non-fuel CASM at under 2%. Non-fuel CASM, as measured by non-fuel costs 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. Delta’s fourth quarter non-fuel CASM rose at a modest rate of 1% year-on-year. ^[1] As domestic re-fleeting, which includes replacing smaller, older airplanes with new, larger airplanes, remains underway, Delta expects to continue to limit growth in its non-fuel CASM at under 2% in the first quarter of 2015.

Sharp Drop In Global Crude Oil Prices Lifts Profit

The biggest boost to Delta’s fourth quarter profit came from lower jet fuel prices. Fuel costs constitute nearly a third of Delta’s total operating cost, and a 50% fall in global crude oil prices over the past few months slashed the carrier’s fuel bill. However, Delta could not take full advantage of the decline in crude oil prices as it had hedged a significant portion its fuel requirement at higher prices. Consequently, the carrier had to purchase fuel at higher than market rates in the fourth quarter, booking a fuel hedge loss of nearly $1.2 billion. ^[1] The rationale behind fuel hedging is that it insulates the airline from a sudden rise in crude oil prices. Other major airlines could also book a fuel hedge loss in the fourth quarter. The only exception to this will likely be American, which does not hedge fuel – a strategy that American adopted from US Airways after acquiring the latter in December 2013. So, American will likely take full advantage of the decline in global crude oil prices in its fourth quarter results due on Tuesday, January 27.

Delta’s Outlook For The First Quarter

Looking ahead, Delta plans to expand its capacity by 5% per year in the first quarter. Effectively, this would be a 3% capacity addition, as the carrier cancelled many flights last year due to winter storms. ^[1] Nonetheless, this healthy capacity expansion will boost Delta’s first quarter top line. Delta also forecasts a healthy operating margin of 11-13%, benefiting from lower oil prices and gains from ongoing domestic re-fleeting. We figure that for full year 2015, Delta’s outlook is bright as crude oil prices are likely to remain weak.

Could Lower Crude Oil Prices Lead To Lower Airfares?

In such a low oil price scenario, Delta should report higher profits in 2015. We expect that these profits will be used to, first, pay down debt, and second, return increased cash to shareholders. Delta’s net debt stood at $7.3 billion at the end of 2014, and the carrier aims to lower this to $6 billion by this year’s end and to $5 billion next year. Delta also plans to return a minimum of $1.5 billion to shareholders through buybacks and dividends in 2015. ^[3] Given these priorities of debt reduction and returns of cash to shareholders, it is unlikely that higher profits driven by lower oil prices will be used by Delta to slash airfares. That said, the fuel price drop has severely hit certain markets such as the Middle East and Russia. So, airlines including Delta could face some pricing pressure in these markets, weighing on their yield growth. However, as long as the demand environment in the domestic market remains strong, airlines will likely not lower their airfares, instead using savings from lower fuel prices to strengthen their balance sheets and boost returns to shareholders.

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1. Delta’s 2014 Q4 earnings form 8-K, January 20 2015, www.delta.com [↩] [↩] [↩] [↩]
2. Delta’s investor update filed in January 2015, January 5 2015, www.delta.com [↩]
3. Delta’s 2014 Q4 earnings transcript, January 20 2015, www.seekingalpha.com [↩] [↩]