Delta Air Lines: What To Expect From 2015 Numbers?

+19.33%
Upside
43.44
Market
51.84
Trefis
DAL: Delta Air Lines logo
DAL
Delta Air Lines

The year 2015 is considered to be a golden year for the US airline industry. Airline companies that were buried under heavy losses for years suddenly began posting impressive profits on the back of depressed crude oil prices. One of the beneficiaries of the oil slump was Delta Air Lines (NYSE:DAL), which enjoyed a notable increase in its earnings over the last 3-4 quarters, driven by significant fuel cost savings. The network carrier utilized the increased cash flows judiciously, by revamping its current fleet, improving its product offering, creating a leaner capital structure, and returning value to its shareholders. Further, the Atlanta-based airline also penetrated into unexplored markets, as well as streamlined its existing operations by entering into code-share agreements and joint ventures with other carriers. In this article, we look back at the key trends witnessed in 2015 and what we expect from its full year results, due for release later this month.

Delta-Price2015

Source: Google Finance

Rising Competition Dragged Down Delta’s Unit Revenue

Relevant Articles
  1. Should You Pick Delta Stock Around $40 After Its Q4 Beat?
  2. After Over 20% Gains In 2023 Will Delta Air Stock Outperform Alaska Air?
  3. Should You Pick Delta Stock At $34 After Q3 Beat?
  4. What To Expect From Delta’s Q3?
  5. Which Is A Better Pick – Delta Stock Or United Airlines?
  6. Delta Air Lines Stock Poised For Strong Gains?

In order to establish an international hub in Seattle, Delta continued to aggressively add capacity at Alaska Air’s home base during the year. This resulted in a cold war between the two airlines which, in turn, created pricing pressure in the Seattle market, impacting Delta’s passenger yields. Further, the network carrier faced stiff competition from Southwest Airlines in Dallas and from the Gulf carriers in other markets. In all, this caused a sharp decline in the airline’s unit revenue and on its revenue growth during the year. However, the world’s third largest airline by traffic experienced a marginal recovery in unit revenue during the December quarter, and has accordingly revised its guidance for the quarter to a decline of approximately 1.5%, as opposed to its previous expectation of a 2.5% to 4.5% drop [1].

 

Currency Headwinds Resulted In Capacity Cuts In International Markets

In the second quarter of 2015, the US dollar began to strengthen against most of the other foreign currencies. While the stronger US dollar made international travel cheaper for US passengers, it severely hit the international air travel for most of the large carriers. Since Delta’s international operations contribute more than 30% of its total revenue, its top line saw a downward trend in the first half of the year. Consequently, the airline decided to reduce its international capacity by 3.0%-3.5% in the last quarter of the year to improve its pricing power and long-term margins. This pullback was focused on markets such as Japan, Brazil, Africa, India, and the Middle East, that were the worst affected by the strengthening of the US dollar and low oil prices.

For 2015, we expect to see a drop in the airline’s international revenue compared to 2014 due to the currency fluctuations. Going forward, we forecast further capacity cuts in Delta’s international capacity as long as the currency fluctuations continue.

DAL-Capacity

Source: Delta Investor Presentation, 17 December 2015

Strategic Investments In Latin America And China Will Improve Long Term Profitability

Over the year, Delta invested heavily on building its Latin American network and restructuring its Pacific operations through equity investments and joint ventures with various carriers. During the quarter, the airline increased its stake in GOL Aereos, the largest Brazilian domestic carrier, to almost 10% to expand its operations in the Latin American markets. The airline also 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. This partnership will allow Delta to leverage its US network with China Eastern’s large domestic presence to enter China, which has surpassed Japan as the largest trans-Pacific market from the US.

DAL-China

 

Source: Delta Investor Presentation, 17 December 2015

Further, in November, the airline expressed its intent to acquire an additional 32% stake in Grupo Aeromexico, a Mexico-based airline in which Delta already holds 4.1% share, through a cash tender offer of approximately $2.50 per share [2]. The airline also expects to launch a joint venture worth $1.5 billion with Grupo Aeromexico by 2016, and has submitted an anti-trust immunity application for regulatory approvals.

In addition to the above mentioned, the network airline has existing joint ventures with Air France/KLM, Virgin Atlantic, and Virgin Australia which encompass more than 270 daily flights and $14.5 billion in annual revenues. 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. In a nutshell, all these strategic investments will enable Delta to expand and diversify its network into high-revenue and high-growth markets inorganically, and improve its long-term profitability.

Fuel Cost Savings To Complement Delta’s Bottom Line

The free fall of commodity prices that began in the second half of 2014 continued to work in Delta’s favor in 2015. The 50% drop in crude oil prices during the year enabled the airline to reduce its jet fuel expenses by more than 33% in the first three quarters of the year. While the carrier has managed to save more than $2.5 billion in fuel costs so far, it could not enjoy the complete benefit of the oil slump since it had fuel hedges for a notable portion of its fuel consumption. Nonetheless, the effect of these lower costs trickled down to the network carrier’s bottom line, resulting in a significant jump in its operating income. Delta’s operating income for the first nine months more than doubled to almost $6 billion, representing a rise of 10% in its operating margin. Since crude oil prices remained weak even in the fourth quarter, the airline is likely to report even higher cost savings for the full year 2015, leading to much higher margins.

DAL-Fuel

Source: Delta Investor Presentation, 17 December 2015

 

Increased Profits Allow Delta To Return Higher Value To Shareholders And Improve Its Balance Sheet

In addition to margin expansion, lower fuel costs have resulted in a significant increase in Delta’s cash flows during the year. In the first three quarters of the year, the network carrier generated operating cash flows of close to $6.5 billion, of which almost $2 billion was used on revamping its aircraft and $500 million were invested in equity investments. Moreover, the airline returned more than $2 billion to its shareholders in the form of dividends and a share buyback program and further expects to return $500-600 million in the last quarter of 2015. In May, the airline also authorized a $5 billion stock repurchase program – more than twice its last year’s program – to be executed by 2017.

Apart from this, Delta paid down more than $2 billion of its long-term debt in the last nine months driven by the higher cash flows. This has enabled the airline to bring down its long-term debt obligations to $7 billion, and improve its return on invested capital. Due to the improved capital structure of the airline, credit rating agencies such as S&P and Fitch have updated Delta’s debt rating to only one notch lower than investment grade. Further, the airline aims to bring down its long-term debt to almost $4 billion in the next two years. This is likely to reinforce investor confidence in the fundamental value of the carrier.

DAL-Cash flows

Source: Delta Investor Presentation, 17 December 2015

 

Overall, we believe that despite the foreign currency headwinds and increased competition, Delta is expected to post impressive numbers for 2015, backed by fuel cost savings. Also, the airline’s long-term strategy to enter the Latin American and Asian markets is well-grounded and is likely to add to its long-term profitability.

See Our Complete Analysis For Delta Air Lines Here

View Interactive Institutional Research (Powered by Trefis):

Global Large Cap | U.S. Mid & Small Cap | European Large & Mid Cap

More Trefis Research

Notes:
  1. Delta’s Investor Update, 5 January 2015, www.delta.com []
  2. Delta Announces Intention To Acquire Additional Shares Of Grupo Aeromexico, 18 November 2015, www.delta.com []