Delta Air Lines, Inc. Earnings: Revenue Sags Again

On Thursday, Delta Air Lines (DAL -1.38%) reported solid earnings for the second quarter of 2016. Adjusted earnings per share reached $1.47, up from $1.27 a year earlier. But the airline giant's results were not as good as they could have been -- and its guidance was subpar, too.

Delta earnings by the numbers

Delta's revenue slipped by more than 2% last quarter, despite a 3.2% year-over-year increase in its capacity. It was still able to grow earnings per share, though: largely because of lower fuel prices and strong non-fuel cost control. Here are some of the key metrics from Delta's Q2 earnings report.

Data source: Delta Air Lines Q2 earnings release. 

Delta's adjusted fuel expense declined about $400 million year over year in Q2, despite the 3.2% capacity increase. However, this actually understates the fuel savings Delta could have achieved.

During the quarter, Delta settled all of its fuel hedges for the remainder of 2016. This pulled $455 million of hedging losses forward into Q2. Had Delta let its hedges expire naturally, it would have posted much higher earnings growth last quarter -- but it would have been locked into higher fuel prices for the rest of the year.

Revenue weakness everywhere

While costs were a bright spot in Delta's earnings report, the company turned in another subpar revenue performance. What's more, passenger revenue per available seat mile (PRASM) was weak across all four of Delta's geographical regions.

Delta's unit revenue declined in every region of the world last quarter. Image source: The Motley Fool.

Domestic PRASM declined 5.6% year over year. In recent months, Delta has repeatedly pointed to fare weakness in the domestic market for the last-minute bookings typically made by business travelers. In retrospect, Delta's 5.2% domestic capacity growth last quarter was far too much.

Delta's international performance wasn't much better. On a year-over-year basis, PRASM fell 4.4% in the transatlantic market, 5.1% in the transpacific market, and 4.9% in Latin America. A portion of these international PRASM declines were caused by the strengthening of the dollar against various foreign currencies.

More capacity cuts: will they work?

Delta doesn't expect the revenue environment to get any better next quarter. The company's Q3 guidance calls for PRASM to decline 4%-6% year over year. At the midpoint, that's roughly in line with its Q2 performance. The year-over-year impact of fuel savings is starting to subside, though. As a result, Delta expects its Q3 operating margin to be flat or down from last year's 21% mark.

There's a good chance Delta is being ultra-conservative with its guidance, having fallen short of its unit revenue projections in each of the last two quarters. Nevertheless, Delta's Q2 revenue performance and Q3 guidance both suggest that Delta needs to slash its capacity plans.

In fact, Delta is doing just that. In the earnings release, Delta announced it is cutting 6 percentage points of capacity in the U.S.-U.K. market during the winter season to cope with the impact of Brexit. This comes on top of other capacity actions Delta announced in May.

As a result, total system capacity will increase just 1% year over year in Q4. With other airlines also pulling back on capacity for the fall, this should drive improvement in Delta's unit revenue trajectory. That said, even these actions are unlikely to get Delta back to unit revenue growth by year-end. It will likely require more time -- and more capacity cuts.