Delta Is Building a Profit Machine

On Tuesday morning, Delta Air Lines (NYSE: DAL  ) announced that it beat Wall Street's lofty profit expectations once again in the third quarter. Analysts had been expecting that adjusted EPS would increase by more than 50%, from $0.90 to $1.36, but Delta managed to produce adjusted EPS of $1.41. This puts Delta on pace to earn a record profit in 2013.

Delta's strong Q3 performance was driven by continued improvement in unit revenue, lower fuel prices, and a dramatic slowdown in non-fuel unit cost growth. The best news for shareholders is that some of Delta's initiatives to improve unit revenue and reduce costs are just getting started. This should lead to even better results and another record year in 2014. To put it bluntly, Delta's management is building a profit machine.

Revenue growing steadily
Delta's unit revenue grew by 4% in Q3, despite a 2.6% year-over-year increase in capacity. To achieve this unit revenue growth, Delta also had to overcome the weakening of the yen, which affected demand among Japanese tourists for Delta's flights between Japan and beach markets like Hawaii.

The fourth-quarter-revenue outlook is also strong, according to Delta's management team. While a variety of unusual factors will affect monthly revenue growth (such as the one-week calendar shift of Thanksgiving and the impact of Hurricane Sandy in 2012), Delta's holiday bookings have been strong overall. Moreover, the impact of the recent government shutdown has been relatively muted for Delta, reducing revenue by just $20 million-$25 million.

Delta expects to continue growing unit revenue faster than the rest of the industry in 2014. On the earnings call, executives pointed to a few initiatives that will help Delta achieve this goal. Delta's joint venture with Virgin Atlantic will go into effect on Jan. 1, and the carriers will align their schedules in late March, improving access to London Heathrow Airport. Delta will also finish putting flat-bed seats on all its international aircraft next year. Lastly, Delta is paring back capacity at its Tokyo hub in order to minimize the impact of the weak yen on its revenue.

Cost creep comes to a halt
Unit cost growth has been a significant concern for Delta in recent years, particularly due to wage inflation. Non-fuel unit cost growth peaked at 5.7% in Q4 of 2012, before moderating in the next two quarters. Last quarter, non-fuel unit costs increased just 1.1% year over year, indicating that Delta's structural cost reduction efforts are starting to pay off.

The remarkable thing about this performance is that Delta's domestic fleet restructuring -- one of the most promising parts of its overall cost reduction program -- is just beginning.

Delta will take delivery of 88 Boeing (NYSE: BA  ) 717 aircraft coming from AirTran by the end of 2015. These small mainline jets will replace 35-year-old DC-9s that are ripe for retirement while also allowing Delta to reduce its reliance on inefficient 50 seat regional jets. Delta will also add at least 40 large regional jets as part of its bid to eliminate more than half of its small regional jet fleet over the next two years.

Delta is just starting to put these larger planes into service in the fourth quarter, so the fleet restructuring had virtually no benefit in the third quarter. Adding more large regional jets and small narrowbodies to the fleet will continue to push down unit costs at Delta, and should hold unit cost growth below the rate of inflation over the next few years.

Foolish bottom line
Delta has been an outperformer within the airline industry for the past two years. Last quarter was Delta's most profitable quarter ever, and the carrier seems to be on a trend for continued improvement going forward.

This is creating a flood of free cash flow -- more than $1.8 billion year to date -- that will eventually make its way back to investors. While Delta shares have nearly tripled since late 2012, the stock still trades at a reasonable valuation of less than 10 times earnings. This suggests that there's plenty of upside left for Delta.

The next fuel revolution
Delta is one of many businesses affected by high oil prices. Lots of companies are trying to provide better energy solutions for the future, but one home run investing opportunity has been slipping under Wall Street's radar for months. This little-known stock... holds the key to the explosive profit power of the coming "no choice fuel revolution." Luckily, there's still time for you to get on board if you act quickly. All the details are inside an exclusive report from The Motley Fool. Click here for the full story!


Read/Post Comments (0) | Recommend This Article (0)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

Be the first one to comment on this article.

DocumentId: 2695047, ~/Articles/ArticleHandler.aspx, 4/24/2014 7:46:07 AM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...


Advertisement