• Delta's third quarter revenues declined by 27% over over Q3 2019, fairly in-line with the 29% contraction in capacity.
• With the progress in mass vaccination, passenger numbers at TSA checkpoints have observed a strong recovery in recent months. Notably, the company's fourth quarter capacity is likely to be 20% lower than Q4 2019.
• The company reported $25 billion of long-term debt in Q3 FY2021, assisted by multiple debt and equity offerings.
• Ongoing vaccination and revenge tourism in the coming quarters is expected to propell revenues and earnings.
Below are key drivers of Delta Air Lines value that present opportunities for upside or downside to the current Trefis price estimate.
Fuel Expense % Passenger Revenue: Fuel expense is the largest operating expense incurred by an airline. For Delta, it has averaged around 25% (as a percentage of Passenger revenue) over the last 7-8 years. It stood at 33.4% in 2014. However, due to plummeting crude oil prices since mid-2014, fuel expenses have declined substantially for the airline. It fell to 18.8% in 2015 and 16.7% in 2016. However, there was a reversal in the trend through most of 2017. Consequently, the percentage jumped to 18.3%.
Since the outlook for oil prices is strong, we expect the fuel costs to increase in the near term, recovering to their historic levels by the end of our forecast period. If crude oil prices jump further, and fuel expenses rise to 27% instead of the current forecast of 25% by the end of the Trefis forecast period, then there could be a potential downside of around 10% to the Trefis price estimate for Delta's stock.
Passenger Yield: Delta’s Passenger Yield increased from $0.126 in 2009 to $0.172 in 2014. However, due to increased competition in the domestic market, the airline experienced pricing pressure, which led to a sharp fall in its passenger yield in 2015. Delta's passenger yield declined to $0.166 during the year. However, we expect the competition to ease out, causing the airline's passenger yield to grow steadily to $0.178 by the end of 2020. If, however, the carrier's passenger yield rises more than anticipated to grow to $0.200 by 2022, then there could be a potential upside of more than 10% to the Trefis price estimate of Delta's stock.
Delta Air Lines is one of the largest passenger airlines in the world operating an extensive domestic and international network that spans the Americas, Europe, Asia-Pacific, Africa, the Middle East, the Caribbean, and Australia. Delta and its subsidiaries operate over 15,000 flights every day. The carrier is headquartered in Atlanta.
Delta's route network is centered around the hub system it operates at airports in Amsterdam, Atlanta, Cincinnati, Detroit, Memphis, Minneapolis-St. Paul, New York-JFK, Paris-Charles de Gaulle, Salt Lake City, and Tokyo-Narita. Each of these hub operations includes flights that gather and distribute traffic from markets in the geographic region surrounding the hub, to domestic and international cities, and to other hubs. Delta's network is supported by a fleet of aircraft that is varied in terms of size and capabilities, giving it the flexibility to meet corporate demands for travel.
It also has alliances with other domestic and foreign airlines to aid its network. These alliances include code sharing, reciprocal frequent flier program benefits, joint promotions, and common use of airport gates, among others. Delta is also a part of SkyTeam, which is one of the three major global airline alliances.
Delta has one of the largest service networks among other US airlines. A large service network enables the carrier to attract corporate travelers to its loyalty program, which supports higher yields as many corporate travelers opt for first-class travel.
Delta has made equity investments in Virgin Australia, Virgin Atlantic, Aeromexico, GOL, and China Eastern. These investments increase the carrier's presence in important international air travel markets, boosting its passenger traffic and revenues.
Fuel expenses constitute the single largest cost head for airlines, making them vulnerable to hikes in crude oil prices. For Delta, fuel costs constitute around a third of its total operating expense. To reduce vulnerability to fuel price volatility, Delta engages in fuel price hedging.
Demand for flights is highly correlated to global economic growth. Thus, a decline in economic growth, or recession, reduces demand for flights, impacting passenger traffic for airlines. On the other hand, steady growth in the global and U.S. economy grows demand for air travel, allowing airlines to raise their airfares, occupancy rates, and profits.
Many airlines, including Delta, are figuring out ways to grow their top lines through ancillary heads such as baggage fees, access to on-board WiFi/food/drinks, etc. Accordingly, airlines are investing in enhancing their product offerings that include in-flight WiFi and other entertainment options, improved lounge facilities, and extra-legroom seats.
According to an Amadeus/IdeaWorks study, North American airlines collectively produce one of the largest streams of ancillary revenues compared to other regions. A majority of the increase is attributable to stronger merchandising efforts by the carriers, as well as the addition of more à la carte services for sale.
During the past decade, low-cost carriers such as Southwest and JetBlue have gained significant market share in the U.S. Looking ahead, we believe that these low-cost carriers will likely continue to grow their market share, as their lower fares attract passenger traffic.
The U.S. airline industry has seen many mergers and acquisitions in the last decade, including the five big combinations of US Airways and America West, Delta and Northwest, United and Continental, Southwest and AirTran, and American and US Airways.
A more consolidated industry has worked to improve the profits of all airlines. A fewer number of players in the market has made it easier for the remaining airlines to add capacity with restraint. Prior to this consolidation in the airline industry, individual airlines were adding capacity at higher rates in an attempt to grow their market shares. This rapid capacity addition resulted in an oversupply of seats, reducing the margin and profits of all carriers.
Going forward, we believe that as long as airlines add capacity with discipline, the industry should remain profitable.