Delta Air Lines reiterated its long-standing financial targets to Wall Street during a recent investor day, outlining how it plans to work towards them in 2017 even as it faces various headwinds.
The Atlanta-based carrier will focus on the positive demand trends that it has seen since November coupled with its various ongoing revenue initiatives to return to positive passenger unit revenue territory and close in on its annual operating margin target of 17% to 19%, executives said during the event on 15 December.
“Our goal now is, in 2017, to sustain the momentum we have,” says Ed Bastian, chief executive of Delta.
That momentum includes an improving demand environment, more disciplined capacity growth, rising revenues from its branded fares initiative and cost certainty with its new pilots contract despite short-term pressure.
In 2017, Delta expects an operating margin roughly 100 to 200 basis points below its annual target. This is largely the result of cost pressure from the contract its pilots ratified earlier this month and up to 6% increases in pay for other employees that will drive a 2% to 3% increase in non-fuel unit costs, roughly 100bps higher than its annual goal, for the year.
The carrier will grow available seat miles by just 1% in 2017, a point lower than its annual 2% increase target, to help offset the cost pressures. Domestic capacity will grow roughly 2% and international capacity will shrink by roughly 1%.
“While the 2017 outlook… appears somewhat aspirational on the revenue side, we are encouraged by near-term trends and [Delta’s] commitment to rein in supply to meet margin targets,” says Rajeev Lalwani, an analyst at Morgan Stanley, in a report.
PRIORITISING UNIT REVENUE
“Unit revenue is our number one financial priority,” says Bastian. “We need to get the unit revenues moving in the right direction.”
Delta may just achieve that target in 2017. It forecast flat passenger unit revenue (PRASM) in the first quarter, its first such guidance after seven straight quarterly declines through September.
“Almost instantly, almost to the week after election day, something changed,” said Glen Hauenstein, president of Delta, during investor day. Demand “turned a corner” that week, with November PRASM falling just 1% after a 6.5% drop the month before.
The airline expects a roughly 3% decrease in system PRASM in the fourth quarter, the better end of its prior guidance.
Analysts at Evercore estimate a roughly 1.5% drop in passenger unit revenue this month, driven by the shift in some holiday travel to January, based on Delta’s updated quarterly forecast.
The carrier’s planned capacity discipline in 2017 will also help propel unit revenues towards positive territory. It plans to concentrate growth in the domestic market, which it views as the strongest among its four segments, including Atlantic, Latin America and the Pacific.
Delta forecasts US economic growth of greater than 2% in 2017, says Bastian. Economic growth is viewed as a proxy for a healthy level of airline capacity growth in mature markets.
The Atlantic remains the most challenging region for Delta. High levels of capacity growth and new long-haul low-cost carrier services are among the drivers of this, which could see the segment as the only one reporting negative PRASM in 2017, say executives.
Delta will increasingly focus its transatlantic flying on its European partner hubs and increase seasonality in response to the yield pressures, says Hauenstein. Routes to “spokes”, or destinations that lack a connecting partner on the European end, will be reduced.
The US carrier has immunised joint ventures with Air France, Alitalia, KLM and Virgin Atlantic Airways. The four airlines maintain hubs in Amsterdam, London Heathrow, Milan, Paris Charles de Gaulle and Rome.
Delta's Pacific segment, long its weakest and subject to a large number of capacity cuts concentrated in Japan, may generate its first profit in years this year, says Bastian.
REVENUE ENGINE
Delta is leading the pack on new revenue generation among US carriers. It debuted a suite of branded fares in early 2015, something its competitors American Airlines and United Airlines only plan to begin emulating in 2017, and launched the ongoing wave of fleet upgauging in the market in 2013.
Expanding cabin segmentation will be a big focus in 2017. The rollout of its no-frills basic economy fare is expected to be complete by the middle of 2017 and it will be introduced in more international markets through 2018.
In addition, the airline will debut its latest cabin segment, the “premium select” premium economy cabin, with its first Airbus A350-900s in the second half of the year.
Delta plans to offer up to five cabin segments, ranging from basic economy to its Delta One business class, when its segmentation programme is fully deployed.
Delta
Branded fares are paying off. Revenues increased by about $200 million to $1.4 billion this year and are forecast to nearly double to $2.7 billion in 2019. The programme is expected to bring in roughly $1.7 billion in 2017.
“Basic economy is a corporate fare increase by another name,” says Jamie Baker, an analyst at JP Morgan, in a report. “Most contracted corporate travel agreements wall off this fare category given its onerous restrictions, thereby thrusting business travellers into higher priced but more flexible fare categories.”
He calls the no-frills fare class one of the “most creative revenue concepts of the past decade”.
The fact that both American and United are emulating the offering with their own segmentation initiatives suggests that Baker is correct to praise the programme.
Upgauging continues apace at Delta. Executives spoke little of the initiative, which involves shifting from 50-seaters to larger dual-class regional jets, and from large regional aircraft to small mainline narrowbodies, in what has been a successful effort to improve operational performance, generate new revenues and reduce expenses.
"All in, it appears to us that 2017 is setting up to be a solid year from Delta," says Jack Atkins, an analyst at Stephens, in a report. "We expect Delta to remain the industry leader in terms of margin performance despite these headwinds."
Source: Cirium Dashboard
