Thursday, July 24, 2014

ANALYSIS: Delta Posts Second Quarter Profit of $801 million

By Vinay Bhaskara  / Published July 23, 2014

Delta 767 SEA JDL-1Delta Air Lines reported a second quarter profit of $801 million, or $0.94 cents per diluted share, up 16.9% year-over-year (YOY) from $685 million in the second quarter of 2013. The superb financial performance was driven by strong mainline growth in the domestic and Trans-Atlantic operating regions, as well as reduced fuel costs thanks to the substitution of more fuel efficient mainline Boeing 717s for regional jets (fuel efficiency per available seat mile [ASM] increased 1.2%) and lower fuel prices.

Operating revenues leapt up 9.4% YOY to $10.62 billion, led by consolidated passenger revenues, which rose 9.1% YOY to $9.2 billion on a 3.8% YOY increase in yields to 17.37 cents. The improvements in yields helped drive a 5.4% YOY increase in passenger revenue per available seat-mile (PRASM), once again positioning Delta amongst industry leaders in PRASM growth after two to three quarters of (relative pullback). Delta delivered the impressive figures despite a 3.2% YOY increase in ASMS, though traffic as measured in revenue passenger miles (RPMs) increased 5.0% YOY.

The 3.2% increase in capacity represents an interesting up-shift in capacity growth on the part of Delta after years of impassioned rhetoric on the virtues of aggressive capacity discipline. Part of the increase certainly arises from fleet effects. As Chief Financial Officer Paul Jacobson noted on the carrier’s quarterly earnings call, Delta’s domestic capacity grew 3% despite 4% fewer departures, largely because of Delta’s introduction of the 717. However, because the capacity increase occurs due to up-gauges, the operating cost per seat is better and trip costs (based on a reduction in frequencies) are similar, which means that the capacity increases are margin-expansive.

Delta 767 CDG-SEA-2Broken down by segment, mainline domestic passenger revenues rose 15.7% YOY to $4.49 billion on a 10.2% increase in unit revenues and a 7.4% YOY increase in yields. Latin America revenues jumped 22.6% to $604 million on a massive YOY capacity expansion of 23.5%. The capacity growth did put pressure on fares, driving a minor 0.7% reduction in unit revenues on a 0.4% drop in yields. Trans-Atlantic flying recovered after several quarters of revenue and unit revenue declining, with revenue rising 5.5% YOY to $1.66 billion on a corresponding 7.2% increase in unit revenue and a 5.6% rise in yields. Pacific flying continues to struggle thanks to increases in competitive capacity and the general slowdown of economies in the region, with revenues falling 2.6% YOY to $819 million on a 3.2% reduction in unit revenues and a 1.9% drop in yields. Regional domestic revenues fell 0.8% to $1.68 billion, though yields still edged up 0.2% over 2013. Cargo revenues fell 1% YOY to $230 million.

After several quarters of successive devaluation, the value of the Japanese yen has stabilized after several quarters thanks to a shift in focus to fiscal matters in the economic plan of Japanese premier Shinzo Abe. Delta is the US carrier most exposed to fluctuations in the yen on an absolute basis thanks to its hub at Tokyo Narita, and despite the stabilization, net of hedges, the currency effect still cost Delta $10 million.

Asian operations as a whole are likely to struggle financially thanks to the steady spool up of operations in Seattle. However, despite a 30% increase in capacity, international unit revenues ticked upwards by 2% and domestic unit revenues grew 6% YOY on a 25% increase in capacity. As with any YOY comparisons, the basis of comparison is important, and for the moment, Seattle (by Delta standards) remains a low-revenue hub. Conversely, high fare hubs at New York and Atlanta continued to drive profitability, with double digit unit revenue increases in both markets, buoyed particularly by trans-continental operations in New York.

Delta’s equity investments, a small-scale facsimile of Etihad’s famed “equity alliance,” also paid dividends with Heathrow revenue rising 24% and unit revenues growing 5% thanks to the partnership with Virgin Atlantic. In Latin America, partnerships with Gol and Aeromexico deliver feed equivalent to one fourth of Delta’s traffic on routes to Brazil and Mexico respectively, and helped drive $36 million in incremental revenues in the quarter. Venezuela offsets some of the improvement in Latin America, with $190 million in trapped revenues and a RASM hit of 3-4 percentage points in coming quarters.

 Image Credit: Lonnie Craven / Miami-Dade Aviation Department

Image Credit: Lonnie Craven / Miami-Dade Aviation Department

Operating expenses rose just 2.8% in the second quarter to $9.04 billion. Rising labor costs (up 6% YOY to $2.04 billion) were offset by a 6.2% decrease in fuel costs to $2.43 billion (down from$2.59 billion in Q2 2013), which reflected a 3% drop in fuel prices per gallon to $2.93. Overall cost-line performance was mixed; maintenance and landing fee expenses declined while depreciation and sales expenses increased. Profit sharing expenses skyrocketed 188.1% YOY to $340 million. Consequently, consolidated operating costs per ASM (CASM) fell less than 0.1% YOY to 14.63 cents, while CASM excluding fuel remained flat YOY.

After several quarters of operational losses (even as it remained margin positive thanks to the reduction in crack spread), Delta’s controversial Trainer refinery recorded an operating profit of $13 million and is projected to break-even in the third quarter. And Delta CEO Richard Anderson noted on the earnings call that Delta continues to make incremental improvements on an operating basis with changes in oil supply.

“The important thing for our strategy is to continue to lower the overall input costs for the plant through domestic crudes,” stated Mr. Anderson, “[Thus]… we can help to create that cushion in a low distillate crack environment where we can make a little bit money at the refinery while also enjoying the full benefits lower crack spreads at the airline.”

Third quarter operating margin came in at a sizzling 14.9% on a near doubling of operating profit to $1.58 billion. And third quarter operating margin (leveraging Delta’s strength in the Atlantic) is expected to jump even higher to 15-17%. Free cash flow came in at $1.54 billion, cementing Delta’s market leadership in the metric thanks to a conservative capital allocation strategy and a deferred tax asset.

Once again, Delta has delivered market-leading financial results. Moreover, Delta is in a unique position that allows it to maintain that level of financial performance. Its hubs in New York, Los Angeles, and Seattle are all in a nascent developmental stage, which means that a clear pathway to PRASM and profit growth exists.

Contact the author at
Jeremy Dwyer-Lindgren contributed to this report.

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