2015 Earnings Review: Fuel Cost Savings Cause Delta’s Profits To Surge, Despite Currency Tailwinds

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DAL: Delta Air Lines logo
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Delta Air Lines

The stock of Delta Air Lines (NYSE:DAL) closed 3% higher on Tuesday, 19th January 2016, after the airline posted an impressive set of financial numbers for the full year 2015, driven by a significant drop in fuel costs during the year [1]. Despite a decline in its unit revenue, the third largest airline (by traffic) reported a 30% jump in its adjusted earnings, on the back of fuel cost savings of $2.3 billion. The Atlanta-based airline utilized the increased cash flows to re-fleet its existing aircraft, enhance its product offering, improve its balance sheet, and return value to its shareholders. Going forward, the network carrier plans to continue to penetrate into unexplored and under-served markets by entering into code-share agreements and joint ventures with other carriers. Let’s take a quick look at the key highlights of Delta’s 2015 earnings release.

We currently have a price estimate of $51 per share for Delta Air Lines, which is 10% higher than its current market price. We will update the model shortly to incorporate the company’s latest guidance.

DAL-Jan16

Source: Google Finance

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Capacity Discipline Helped Delta To Reduce Currency Tailwinds

With the strengthening of the US dollar in 2015, Delta felt a sharp decline in their unit revenue, leading to a fall in their international revenues. In order to cope with this rising trend, Delta proactively pulled back its international capacity by 3.0% to 3.5%, particularly in countries such as Japan, Brazil, Africa, India, and the Middle East, that were worst affected by the strengthening of the US dollar and low oil prices. This enabled the airline to restrict the steep fall in unit revenues to only 3%, as opposed to its previous guidance of a 2.5%-4.5% drop. Overall, the airline’s system capacity grew by 3% compared to the last year, as the airline remained focused on expanding its services in higher margin markets as New York, Seattle, and Los Angeles. Further, the airline’s passenger traffic increased 3% on a year-on-year basis, largely due to its existing code-share agreements and joint ventures with other carriers. Moreover, the airline’s load factor (occupancy rate) improved by 240 basis points to 85.2%, implying that the carrier flew fuller flights compared to last year. Consequently, Delta posted a slight increase in its total revenue of $40.7 billion, largely in line with the market expectations.

Lower Fuel Costs Drive Higher Margins

In tandem with the over 50% fall in crude oil prices over the last year, Delta’s average fuel price dropped almost 45% to $1.90 per gallon. However, due to the airline’s policy to hedge a portion of its fuel consumption, it had to suffer hedging losses and mark-to-market adjustments, which increased its fuel cost to $2.23 per gallon. Despite this, the carrier realized fuel cost savings of close to $2.3 billion (after adjustment), which trickled down to its bottom line. The airline’s reported adjusted pre-tax income of $5.9 billion, an increase of approximately 30% on a year-on-year basis, and delivered net income of $3.7 billion, or $4.65 per share, almost 40% higher than a year ago.

Improved Balance Sheet

The increased cash flows from lower fuel costs enabled Delta to reduce its long-term debt by almost $1.5 billion, bringing down the net debt to $6.7 billion in 2015. This implies that the airline is on track for its target of achieving net debt of $4 billion in the next couple of years and gaining an investment grade credit rating from S&P and Fitch. In addition, the airline returned $2.6 billion to its shareholders, via dividends of $360 million, and share repurchases to the amount of $2.2 billion during the year. This indicates that Delta returned also 70% of its free cash flows to its shareholders, significantly higher than its long-term target of 50%. Besides this, the carrier also invested its cash flows into acquiring aircraft, fleet modifications, and six slot pairs at London’s Heathrow airport.

DAL-netdebt

Source: Delta Announces 2015 Financial Results, 19th January 2016, www.delta.com

Going Forward

For the full year 2016, the network carrier plans to keep its capacity growth in the range of flat to 2%. Most of the capacity additions will come from the domestic markets, while the international capacity will remain weak due to the large reductions made during the last quarter of 2015. For the first quarter of 2016, the airline aims to grow its capacity by 2%-3%, which will be driven by 4%-5% growth in the domestic capacity, and 2%-3% decline in its international capacity. The airline expects the currency headwinds to continue to pull down the unit revenues even in the March quarter, resulting in a decline of 2.5%-4.5% in the metrics during the quarter. On the cost side, Delta forecasts fuel costs savings of over $3 billion for the full year, based on current oil prices. Consequently, it targets to deliver operating margin of 18% to 20% in the first quarter.

DAL-1Q16

Source: Delta Announces 2015 Financial Results, 19th January 2016, www.delta.com

Overall, in 2016, Delta will remain focused on penetrating into high demand and high margin markets through joint ventures and equity investments, while streamlining its operations in the challenging regions, which will boost the airline’s bottom line. In addition, the airline will continue to realize fuel cost savings in the coming quarters that will enhance its earnings.

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Notes:
  1. Delta Announces 2015 Financial Results, 19th January 2016, www.delta.com []