ANALYSIS: Delta investments could have big payoff

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Delta Air Lines has bet big on a number of headlining investments that it believes could payoff with billions of dollars in financial benefits during the next three years.

The Atlanta-based SkyTeam Alliance member made one-time investments of more than $866 million during the past year. These include a 49% stake in Virgin Atlantic Airways earlier this month, a major restructuring of its regional fleet that began in June, the purchase of the Trainer oil refinery in April and a slot swap at New York's LaGuardia and Ronald Reagan Washington National airports with US Airways that closed in December 2011.

Delta could benefit from up to $2.36 billion in combined cost savings and new revenue as a result of these four investments by 2015, according to Flightglobal research.

Flightglobal Research

"When we have those opportunities [to increase access at Heathrow] or we have the opportunity to vertically integrate in the Trainer facility those are important investments and they are important investments for five, 10 years from now," said Richard Anderson, chairman and chief executive of Delta, during an investor day on 12 December.

These benefits are largely in addition to a previously planned $1 billion cost reduction programme at the airline, which includes the previously mentioned fleet restructuring as well as improvements to its maintenance programme, restructured distribution platforms and staffing efficiencies.

Paul Jacobson, chief financial officer of Delta, said that the carrier anticipates the first $600 million in savings from the programme to be felt during the second half of 2013, during the investor day.

Virgin Atlantic

Delta announced that it would buy a 49% stake in Virgin Atlantic from Singapore Airlines for $360 million on 11 December. It plans to form an immunised joint venture with the iconic British carrier between the UK and USA, which would give the airlines a combined market share of about 25% between the two countries.

Innovata

"It's going to be a once in a lifetime opportunity," said Anderson on the deal. "The opportunity to go into Heathrow and get a 25% market share is only going to come by at that kind of a price once."

Delta Air Lines

Delta anticipates that it will generate $120 million in additional revenue synergies through 2015 from its investment n Virgin. This will come from the increased market share, improved joint operations and larger network of the two carriers, Anderson said.

Glen Hauenstein, executive vice-president of marketing, network, revenue management and alliances at the airline, said that Delta's limited access to Heathrow from New York - it only has three daily flights in the market according to Innovata - was impacting its ability to win business travellers in New York, during the investor day.

"We partner Virgin Atlantic [and] we have taken away really the last reason for corporate clients not to use Delta in New York," he said.

Jonathan Root, an analyst at Moody's Investor Service, said that the investment is "credit positive" to Delta and that it expects both airlines to improve the financial results as a result of the joint venture, in a report.

Regional fleet restructuring

Anderson said that the restructuring of Delta's regional fleet was possible by the combination its pilots contract that was ratified in June and the availability of Southwest Airlines-subsidiary AirTran Airways' Boeing 717-200 fleet at attractive prices. He described the latter as a deal the airline could not pass up.

"We weren't quite sure how we were going to pull it off but we had some ideas," said Anderson. "I'm pleased to say that we've gotten most of the way through the restructuring and we've got a clear line of sight to getting that RJ fleet down to about 125."

The restructuring involves reducing the number of 50-seat regional jets in the carrier's feeder fleet to 125 by 2015 from 312 at the end of September and replacing them with 88 110-seat 717s and 70 76-seat Bombardier CRJ900s.

Delta Air Lines

Ed Bastian, president of Delta, said that the airline anticipates that it will save between $400 million and $500 million from retirements of the 50-seat jets by avoiding heavy maintenance on the aircraft, during the investor day.

"We're never going to do a heavy maintenance check on a 50-seater ever," he said.

Delta expects to come out ahead with the restructuring, even with the new 717 leases and the purchase price of the CRJ900s. Hauenstein said that it costs about 20% less to fly the larger aircraft on the same segments as the smaller jets. He added that this does not include the revenue premiums possible from the addition of first class and economy comfort - Delta's premium economy offering - cabins on those flights.

"I think it pays for itself within three years," said Anderson in response to questions regarding the Bombardier order. He added that it would also likely improve Delta's net debt through improved operating cash flow and avoided maintenance expenses.

The Canadian airframer said that the firm order for 40 CRJ900s with 30 options is valued at $1.85 billion at list prices. It will also assist Delta with phasing out 60 50-seat CRJ200s as part of the agreement.

Trainer

Delta bought the Trainer refinery from Philips for $180 million in June. It invested another $100 million in upgrading the facility and was slated to begin production in October until superstorm Sandy disrupted crude oil supply lines and shut down the plant for three weeks.

Bastian said that the plant is expected to lose between $50 million and $60 million during the fourth quarter due to the shut down. However, he said that the airline anticipates that the plant is set to generate about $280 million in profits and reduce Delta's fuel bill by about $300 million in 2013 now that it is up and running.

Based on these numbers, Flightglobal research estimates that Trainer will generate $840 million in profit for Delta and reduce its fuel expenses by $900 million through 2015 if everything stays equal. However, that proposition is highly speculative.

Jet fuel production levels, the introduction of Bakken crude and leverage that Delta gains in fuel markets are likely to significantly influence the benefits of Trainer to the airline's bottom line. Analysts have widely questioned Delta's assumption that it can increase jet fuel yields to 32% of the facility's output through upgrades and modifications.

The US Energy Information Administration noted that the average yield for jet fuel was 11% for refineries in the continental USA in 2011, and that the highest yields were between 25% and 29% but only for a few months of the year, in a June report.

Delta estimates that it can save between $8 and $10 per barrel of crude by switching to Bakken from West African, Jacobson said. He said that the airline will begin processing Bakken at Trainer during the first half of 2013 but will have to wait for new rail offloading facilities to be completed, which is anticipated to occur by the end of next year, before it could significantly supplement or replace the imported crude.

Anderson added that Delta could also ship jet fuel to its hubs at Detroit and Minneapolis-St. Paul from Trainer when the rail facilities are complete. He said that the airline pays the most for fuel at these hubs, where the crack spread is between $38 and $40 per barrel.

"The presence of Bakken crude oil in the plan is going to have a multiplier effect on the overall profitability given what the plant is able to do," said Jacobson.

Delta has also been able to leverage its new position as a fuel producer to achieve better rates from suppliers. They are competing based on price in order to retain the airline's business because it now has the capability to source lower cost fuel from Trainer and its partners, BP and Phillips 66.

"[This is] part of ancillary benefits we call the halo effect of owning this refinery," said Jacobson. He said that Delta signed a three-year contract with a fuel supplier at Minneapolis-St. Paul with $15 million of annual savings as a result of its production at Trainer.

Volatile global oil markets could also impact Delta's savings and revenue from Trainer.

LaGuardia

The final piece in the jigsaw of major deals during the past year is Delta's slot swap with US Airways at LaGuardia and National airports. Announced in 2009, the deal did not receive final regulatory approval late 2011 and closed that December.

Delta swapped 42 slot pairs at National for 132 pairs at LaGuardia with US Airways under the deal. Another eight pairs in Washington were auctioned to JetBlue Airways and 16 pairs in New York to JetBlue and WestJet Airlines. In addition, it paid US Airways $66.5 million and invested another $160 million in upgrades and a new secure connector between terminals C and D at LaGuardia.

Hauenstein said that the airline has already improved margins by two percentage points on its operations out of LaGuardia, even as it increased capacity by 45% during the first year since the swap. In addition, he said the hub is on-track to be profitable in "perpetuity" from March 2013.

"This is a target that we have devised internally and we have a roadmap to get there and we think it is very, very achievable," he said on the profitability of LaGuardia.

Delta Air Lines LaGuardia routes, December 2012

Innovata FlightMaps Analytics

While these benefits are difficult to quantify and are not included as dollar amounts in Flightglobal's calculations, they are material and will benefit Delta - in the words of Anderson - for five- and 10-years to come. Benefits from the Virgin Atlantic joint venture stand to supplement these benefits, especially as Delta moves into its expanded space in terminal 4 at New York's John F. Kennedy (JFK) airport adjacent to the UK carrier.

Delta Air Lines JFK routes, December 2012

Innovata FlightMaps Analytics

"We're unlocking the reasons systematically that you would not use Delta," said Hauenstein on the New York business travel market. "[Until five years ago] we were known for the shuttles and taking Delta to Florida. And what we have now is something that's very, very, very different and something that is very appealing to the business customer."