Delta $9 Value Could Take Lumps From Bill to Scrap Baggage Fees

A new bill that would limit the ability of U.S. airlines to charge for checked luggage could have a significant impact on Delta Air Lines (NYSE:DAL). Louisiana senator Mary Landrieu this week unveiled the Airline Passenger BASICS Act, which enshrines the right to check in one free bag on any U.S. flight, in addition to other guarantees. If voted into law, the move would have little impact on Southwest (NYSE:LUV) and JetBlue (NYSE:JBLU) as they already allow passengers free checked luggage. But in the case of Delta Air Lines, baggage fees form a crucial part of the company’s business strategy. By separating charges for optional extras, the carrier has built up a sizable ancillary revenue stream which enables it to partially offset high operating costs. Should Senator Landrieu’s bill be successful, Trefis’ otherwise bullish outlook for the airline could potentially come into question.

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Ancillary Revenue Lifeline to Airlines

While there’s no shortage of passengers eager to speak out against baggage fees, the fact remains that transporting checked luggage is a costly business for airlines. Not only does is drive up ground labor costs and increase fuel consumption, but it also creates an opportunity cost through lost cargo revenue. Singling out the travelers responsible for these expenses lets airlines reward those passengers who are lucky or savvy enough to fly without bags.

In 2010 U.S. carriers collected a total of $3.4 billion from baggage fees with Delta and American tapping passengers for the highest amounts at $952 million and $581 million respectively. ^[1] Given that last year Delta posted an annual profit of $593 million and American sunk $471 million into the red, it’s easy to see why they view baggage fees as a lifeline. By combining this revenue stream with other fees, such as rescheduling charges, the carriers keep advertised airfares as low as possible, thereby remaining competitive in the face of a growing low-cost sector.

As the chart below shows, we expect Delta to continue growing its lucrative ancillary revenue stream. This year’s total ancillary revenue forecast of $3.83 billion should rise steadily to $5 billion by the end of the Trefis forecast period. These figures justify Trefis’ bullish stock price estimates of $9.

Bill Would Drive Up Fares, Hit Bottom Line

One of Senator Landrieu’s complaints is that baggage charges are often confusing and less than transparent. As an overview though Delta charges about $25 for one piece of checked luggage on flights within North America with fees rising steeply for additional bags. If the company had to scrap these fees, its ancillary revenues would rapidly decline and operating costs would need to be recouped elsewhere – most likely on advertised fares.

By driving up airfares, this bill creates a less competitive pricing landscape. Business people traveling on day-trips would find themselves subsidizing family holidaymakers, for example, and higher fares would gradually dampen demand. If passenger numbers cannot be maintained, the current estimate for the stock would need reviewing. Try dragging the trend-line above to see how falling ancillary income creates up to a 20% downside on the Trefis valuation.

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1. Baggage Fees by Airline, Bureau of Transportation, Jan 2011 [↩]