3Q Earnings Review: Delta Reports Another Strong Quarter Driven By Fuel Cost Savings

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DAL: Delta Air Lines logo
DAL
Delta Air Lines

As expected, Delta Air Lines (NYSE:DAL), which kick-started the earnings season on 14th October 2015 [1], posted a significant jump in its September quarter earnings on the back of lower fuel prices. Despite the steep decline in unit revenues due to foreign currency fluctuations, the revenues of the Atlanta-based airline remained flat, while the fuel cost savings led to a meaningful increase in its operating margins during the quarter. For the next quarter, the airline expects the unit revenue environment to improve slightly. We expect the weak outlook for the oil price market, along with the improvement in unit revenue, to drive the airline’s earnings in the next quarter.  We briefly discuss the key highlights of Delta’s third quarter earnings release and the guidance for 4Q and beyond.

We currently have a price estimate of $50 per share for Delta, almost 3% ahead of its current market price.

DAL-3Q

Source: Google Finance

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Summary of 3Q Results

  • System capacity grew by 3% during the September quarter leading to an increase of 4% in the passenger traffic.
  • Unit revenue, or passenger revenue per available seat mile (PRASM), fell 4.9% in the current quarter, which was in the mid-range of the company’s initial guidance of a 4.5% to 6.5% decline.
  • Revenue remained largely flat at $11.1 billion, despite the sharp drop in the airline’s unit revenue.
  • Average fuel price was $1.80 per gallon during the quarter, representing a decline of 38% from the same quarter last year.
  • Non-fuel unit cost growth was restricted to close to 1% in the quarter due to benefits from the re-fleeting and cost reduction initiatives.
  • Operating margin improved 5% on a year-on-year basis to 21% due to the fuel cost savings of $1.1 billion.
  • Net profit (Non-GAAP) more than tripled during the current quarter to $1.38 billion, translating into an EPS of $1.74 per share, beating the consensus estimate of $1.71 per share.
  • Free cash flow during the third quarter stood at $1.4 billion of which 40% was returned to shareholders including $107 million of dividends and $425 million of buybacks.
  • Delta generated $2.4 billion in operating cash flow and delivered a return on invested capital of 26.3% for the last 12 months. [2]
  • At the end of the quarter, adjusted net debt was $6.4 billion, and the airline received upgrades from S&P and Fitch. Consequently, Delta is just one notch away from investment grade.

Outlook for 4Q and 2016

Due to a strong domestic demand for air travel, Delta plans to grow its domestic capacity by 3% in the December quarter. On the other hand, it aims to reduce its international capacity by 4.5% in the same period, which would consist of a 20% or more reduction in countries such as Japan, Brazil, Russia, and the Middle East, and constant investment in international markets like Mexico and China. Overall, the airline forecasts a flat system capacity for the last quarter of 2015. Further, Delta expects the unit revenue environment to somewhat improve in the fourth quarter, providing a guidance of a 2.5% to 4.5% decline in the unit revenues during the quarter. On the cost side, the legacy carrier expects its fourth quarter fuel prices to average between $1.75 to $1.80 per gallon (at current oil prices), which is likely to result in fuel cost savings of $750 million (after hedging losses). However, the airline’s non-fuel unit costs are estimated to go up by 2% in the December quarter. Keeping all these factors in mind, the airline expects to generate an operating margin of 16-18% in the next quarter.

Delta aims to spend roughly $1 billion in aircraft acquisition, fleet modification, and acquisition of six slots at the Heathrow Airport in London. In addition, the network carrier plans to return $500 million to its shareholders in the next three months, resulting in a total of $2.5 billion that the airline expects to return to its shareholders in this fiscal year. The airline forecasts its debt obligations to stand at $7 billion at the end of the year. Over the next two years, Delta aims to return more than $6 billion to its shareholders through dividends and share buyback, while reducing its debt to $4 billion over the same period. For 2016, Delta has provisioned higher fuel costs due to the volatile nature of the commodity markets. Further, the airline plans to expand its system capacity by up to 2% in the next year, depending on the demand for air travel.

Long Term Plan – Strategic Investments To Expand In Latin America And China

Delta has been investing heavily on building its Latin American network and restructuring its Pacific operations. During the quarter, the airline increased its stake in GOL Aereos, the largest Brazilian domestic carrier, to almost 10% and entered into a long-term exclusive partnership with China Eastern to build a hub in Shanghai, which includes a 3.5% ownership position in China Eastern. These strategic investments will enable Delta to build gateways to China and Brazil, including hubs in Shanghai and Sao Paulo, which are likely to drive the airline’s volume growth going forward. The network carrier utilized $1 billion of its operating cash flows to fund these strategic investments during the September quarter. In addition, Delta’s partnerships with Virgin and Aeromexico will open opportunities for the airline in Western Europe and Mexico, which will be a significant upside for the airline in the future. Moreover, Delta acquired six additional pairs of slots in London, Heathrow during the quarter, which will further strengthen its position in one of the most important business markets in Europe and enhance its top line growth.

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Notes:
  1. Delta Announces 3Q Results []
  2. Delta’s 3Q Conference Call Transcript []