Delta Q4’16 Earnings Review: Capacity Discipline Leads To Improvement In PRASM, Higher Expenses Weigh Down Earnings

January 13th, 2017 by Trefis Team
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Delta Air Lines (NYSE:DAL) announced its fourth quarter and full year 2016 results on 12th January 2016, beating the consensus for both revenues and earnings. In line with our expectations, the improvement in unit revenues and strict capacity discipline, helped buoy the top line slightly. However, the bottom line continued to be weighed down by higher expenditure on wages (post the new pilot contract) and aircraft maintenance.

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To breakdown the growth in top line, we discuss in detail the three determining factors: capacity, unit revenues, and load factor. Delta grew its capacity by a small amount of 0.9% y-o-y in the December quarter. Most of the capacity growth came in from domestic routes, while internationally the company continued to cut capacity, even in Latin America, (-0.1%), which was the only region to see positive unit revenues. This was done keeping in mind the growing expenses at the carrier, owing to the higher oil prices and new labor contracts, which made a turnaround in unit revenues imperative. Consequently, the restriction of capacity growth to a mere 0.9%, as compared to the smaller players in the industry, bore fruit in the way of a smaller decline in unit revenues, at -2.7% y-o-y. Despite the capacity discipline, the smaller yet continued decline in PRASM, along with a slight drop in the occupancy rate (85.1%) led to a faint revenue fall.

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In terms of costs excluding fuel, the company incurred additional costs of 10.6% y-o-y in the quarter. Of the total increase, roughly 8 percentage points is attributable to the impact of the new pilot contract, which came in effect retroactively from 1st January 2016, totaling $475 million of expense, of which $380 million relates to the first three quarters of the year 2016. Besides, the increases in wages and salaries, aircraft maintenance, contracted services and rents, and landing fees drove the expenses higher. Consequently, Delta’s operating margins came down by over 7 percentage points, resulting in a decline in earnings per share in the quarter.

130117Apart from this, Delta generated $640 million in free cash flows (adjusted for capital expenditure and hedging activities), allowing the company to return approximately $449 million back to its equity owners, in terms of dividends and buybacks. That is, 70% of the free cash flows were returned to the company’s shareholders.


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Going forward, the company intends to continue restricting or even cutting capacity, if needed, in order to see growth in its unit revenues and operating margins. The system-wide capacity is likely to stay flat in the first quarter of 2017, to facilitate growth in unit revenues. In terms of costs, they are expected to keep rising as the crude oil prices go up, and the effect of the new pilot contracts is felt on the bottom line. Accordingly, the operating margin in the first quarter will only be slightly better than that seen in Q4’16. Furthermore, Delta’s management mentioned that its priority is to keep the capacity growth in check until it is able to reach previous levels of operating margins (17%-19%). The company also sees an opportunity to grow its top line through branded fare initiatives, which allows passengers to tailor their travel experience. The incremental revenues expected from this in 2017 is $300 million.

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