Capacity Expansions Will Continue To Drive Delta’s Results Despite Weak Unit Revenue

Delta Air Lines (NYSE: DAL), the third largest network carrier in the US, will release its operating results for the first quarter before the market opens on Wednesday, April 15. According to its traffic results for March ^[1], the airline reported a capacity increase of 5% for the quarter, in line with its guidance, while its passenger unit revenue (revenue per passenger flown per mile) declined by 1.5% due to foreign currency fluctuations. Despite a drag from the strong US dollar, Delta expects to earn 44 cents per share (excluding special items) during the quarter on weak oil prices and capacity additions.

We currently have a price estimate of $46 per share for Delta, approximately 7% ahead of its current market price.

See our complete analysis for Delta Air Lines here

Capacity Additions To Boost Revenue Growth

The Atlanta-based airline expects to report consolidated revenue of $9.41 billion in the first quarter due to an upsurge in passenger traffic. Delta’s passenger traffic for the quarter ended March rose by over 3.5% due to capacity expansions in the domestic and Latin American markets. Apart from launching new flights, Delta is swapping its smaller planes for larger ones to improve its utilization rates. We expect the airline to achieve top-line growth of more than 5% year-on-year, in line with its first quarter guidance.

Delta’s strategy to expand its capacity in Seattle – where the airline is building its international gateway – will continue to reap benefits in the form of increased passenger traffic. Further, the airline has entered into partnerships with a number of airlines over the last month in an attempt to expand its customer base. For instance, Delta entered into an alliance worth $1.5 billion with Aeromexico to offer a wide range of flights between the US and Mexico. The airline also signed a deal with Virgin Atlantic Airways to offer trans-Atlantic flights between the US and the United Kingdom ^[2]. We expect these capacity additions to drive Delta’s revenue growth in 2015 and beyond.

Margins May Suffer Due To Weak Unit Revenue

Based on the preliminary results announced on April 2, the carrier expects its adjusted average fuel price for the quarter at $2.90-2.95 per gallon. Delta’s unit costs are expected to be down 1% compared to the previous year due to domestic re-fleeting and cost reduction initiatives undertaken by the airline during the quarter. However, the airline reported a dip of 1.5% in its passenger unit revenue versus a 1% fall guided by the company, primarily due to the strengthening of the US dollar. Weakness in unit revenue is expected to take a toll on the airline’s margin. Delta forecasts its adjusted operating margin to be in the range of 8-9% for the quarter compared to its previous guidance of 11-13%.

Moreover, Delta plans to add capacity at a moderate rate of 2-3% during 2015, unlike other large network carriers such as American and United who continue to adopt capacity discipline. This, coupled with capacity expansions by low-cost carriers such as Southwest and JetBlue, will further create pricing pressure in the market, resulting in lower international earnings. Despite this, the airline expects to generate strong cash flows to the tune of $800-900 million during the quarter, of which $500 million has already been returned to the shareholders in the form of share repurchases and dividends.

We believe that Delta’s focused capacity additions, along with low crude oil prices, will lead to a strong quarter for the airline despite the weakness in passenger unit revenue.

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1. Delta Reports March Traffic Results, 2nd April 2015, www.delta.com [↩]
2. Delta and Virgin Atlantic Partnership [↩]