Any one who has listened to a Delta Air Lines investor presentation in the past two years knows the drill – margin improvement, returning capital to shareholders and building a balance sheet that equals or surpasses those of investment grade industrials.
Management of the Atlanta-based carrier spun the same lines at its annual investor day on 11 December, citing continuing financial improvement at the already strong carrier that has it on track to generate “well in excess of $5 billion” in pre-tax income in 2015, says chairman and chief executive Richard Anderson.
“2015 will be a fantastic year,” he says in his opening remarks. “I think by any measure, we are the best run airline in the world.”
Driving Delta are the benefits from a number of revenue generating and cost saving initiatives that the airline has begun in recent years, as well as the strong demand environment and falling oil prices.
“We believe DAL’s solid string of results can continue,” says Hunter Keay, an analyst at Wolfe Research, in a report on investor day today. He adds that their guidance at the previous two investor days has been very close to their actual results.
INITIATIVE BOOST
Initiatives underway at Delta include the new branded fares announced earlier in December, the investment in Virgin Atlantic Airways in 2013, network changes that range from the build-up of a new Pacific gateway in Seattle to the closing of hubs in Cincinnati and Memphis, and its regional refleeting that will see hundreds of 50-seat regional jets replaced by 76-seat models or mainline aircraft by the end of 2015.
The branded fares alone are expected to generate about $250 million in additional revenue annually in 2015 and $1.5 billion annually by 2018, says Glen Hauenstein, chief revenue officer of Delta. He adds that they will be able to improve this guidance once after the brands are introduced and they fine tune the actual fare differences based on demand.
The carrier’s international premium cabin will be called Delta One and domestic premium cabin First Class, extra legroom economy seats Comfort+ and economy will be split between Main Cabin – essentially what comes with an economy ticket it sells today – and a bargain basement Basic Economy fare that includes no extras, like assigned seating or premier frequent flier points. The new brands will be introduced for travel after 1 March 2015.
Delta expects a $200 million revenue benefit from its Virgin Atlantic investment in 2015, says president Ed Bastian. This comes as unit revenues and operating margins on the carriers US-UK joint venture continue to improve.
“I can tell you safely that our results have thoroughly exceeded any expectations we had,” he says on the purchase of a 49% stake for $360 million. He adds that they expect to make back this investment by the end of 2015.
The network changes have allowed Delta to have the “hubs we want”, as Hauenstein puts it. The biggest recent changes are the restructuring of its Pacific network and related build up at Seattle-Tacoma International airport where it plans to have 120 departures by the end of 2015, which is up from about 80 today.
Delta plans to reduce Pacific capacity by 6% to 8% in 2015, says Bastian. This will come from a reduction of intra-Asia flying from Tokyo Narita International airport and a shift to smaller Airbus A330 and Boeing 767-300ER aircraft from Boeing 747-400s on flights into the region.
The goal of these changes is to increase Pacific operating margins by five to 10 percentage points by 2018, he says.
Delta continues to reap the benefits of its refleeting initiative. Bastian outlines the well-spun narrative of increased efficiency by increasing capacity on fewer departures, adding that they expect the average number of seats per departure to increase by 15% from 2012 to 2017, when the majority of its narrowbody fleet changes are complete.
These changes include the addition of about 10 to 15 seats and new interiors on about 200 Airbus A319, Airbus A320 and Boeing 757 aircraft, says Gil West, chief operating officer of Delta.
In addition, Delta’s order for 25 Airbus A330-900neos and 25 Airbus A350-900s is expected to reduce per seat costs by at least 20% over the 747s they replace when deliveries begin in 2017.
UNDERLYING STRENGTH
Delta is on-track to generate $4.5 billion in pre-tax income this year, which would represent a 70% increase over 2013, says Bastian. Return on invested capital is expected to reach 20% in 2014.
This is driven by continuing strong domestic demand and falling oil prices. Demand domestically is expected to outweigh some international “headwinds”, including significant competitive capacity increases across the Pacific and the weakening US dollar against the Japanese yen and Euro, says Bastian.
The previously mentioned Pacific network changes are in response to the headwinds in the region.
The decline in oil prices is expected to result in a roughly $150 million fuel hedge loss that will be partially offset by a roughly $75 million profit at the Trainer refinery in the fourth quarter, says Bastian. The airline anticipates an average fuel cost of $2.63 and $2.68 per barrel during the period.
In addition, the change in oil prices is expected to drive a $1.7 billion net benefit to Delta’s bottom line after a $1.5 billion hedge loss in 2015, he adds.
The spot cost of a barrel of Brent crude – the measure of fuel costs that Bastian recommends to investors – was $64.24 at close on 10 December. This is down about 44% from a high of about $115.19 per barrel in the middle of June, US Energy Information Agency (EIA) data shows.
Delta has tightened its fourth quarter guidance as a result of the positive trends. Operating margin is expected to be in the 11.5% to 12.5% range, passenger unit revenues will increase 1% to 1.5% on a roughly 3.5% increase in capacity and unit costs excluding fuel and special items will be up about 1%.
While Delta will continue to improve – maybe even achieving the investment grade industrial characterisation that Anderson and other executives seek – its lead on other US mainline carriers may mean the room it has for financial improvement may be limited compared to its peers.
“We simply believe other airlines have the opportunity to expand margins and grow earnings at a faster rate,” says Keay. “In many ways, DAL has become a victim of its own success achieving progress at a faster rate than AAL [American Airlines] and UAL [United Airlines].”
Source: Cirium Dashboard
