5 Things Delta Air Lines, Inc.'s Management Wants You to Know

Delta Air Lines, Inc. continues to profit from its management team's willingness to go against the industry consensus.

Aug 21, 2014 at 11:15AM

Delta Air Lines, (NYSE:DAL) has led the airline industry in a remarkable renaissance in the last 2 years or so. Delta stock has more than quadrupled, thanks to rapid margin expansion and increasing investor confidence.

In Q2, Delta once again reported record quarterly earnings. On the company's earnings call last month, Delta's management team talked about global demand trends and their strategic initiatives going forward. Here are 5 key points that Delta executives wanted to emphasize for investors.

The new Seattle hub is working

"Part of our Pacific restructuring is building out the Seattle gateway. Our Seattle international franchise is doing well... The domestic unit in Seattle also continues to perform well, producing unit revenue improvement in line with our system averages." -- Delta Air Lines President Ed Bastian 

Airline Alaska Air Group Alk Boeing

Delta is challenging Alaska Airlines in the Seattle market (Photo: Alaska Airlines)

Delta has been rapidly growing in Seattle recently. The airline is looking to build up a solid international gateway in Seattle while reducing its reliance on market-leader Alaska Airlines for connecting traffic.

In the last few months, Delta has added daily nonstop service from Seattle to London, Seoul, and Hong Kong. It is supporting this expansion with new short-haul flights to almost every major city on (or near) the West Coast.

So far, this growth seems to be working. Delta's unit revenue in Seattle rose last quarter despite all of its capacity growth. As its new routes mature in the next couple of years, Delta's profitability in Seattle should continue to rise.

Moving to larger jets is boosting margins

"This up-gauging is producing meaningful operating leverage. For the June quarter, we produced 3% higher domestic capacity on almost 4% fewer departures." -- Delta Air Lines CFO Paul Jacobson

A major facet of Delta's profit improvement plan is its domestic fleet restructuring. In 2012, Delta announced plans to reduce unit costs by retiring most of its 50-seat regional jets by the end of 2015. These are being replaced by a combination of small mainline aircraft (110-seat Boeing 717s) and large regional jets (76 seat CRJ900s).

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Delta Air Lines is saving money by replacing inefficient 50-seat jets with larger planes (Photo: The Motley Fool)

These larger planes are significantly more fuel-efficient, and Delta can now carry more traffic with fewer planes. That saves on labor costs, airport costs, and maintenance costs. Delta expects to retire 47 small regional jets in the second half of 2014, and another 80-90 in 2015. Thus the savings from this fleet restructuring will continue to grow.

Delta's joint venture with Virgin Atlantic is helping

"On the corporate volumes, clearly Virgin has been a big assist with respect to our being able to get a stronger foothold in the lucrative JFK-Heathrow marketplace, particularly with the financial services providers. And we continue to see very strong growth in New York." -- Delta Air Lines President Ed Bastian

In 2012, Delta made a strategic investment in struggling UK airline Virgin Atlantic. The two carriers have since formed a joint venture for flights between the U.S. and the U.K. This has dramatically boosted Delta's presence at London-Heathrow -- a key airport for international business travel.

The Delta-Virgin Atlantic joint venture is now No. 2 in market share on the popular New York-London route. This in turn is helping Delta win corporate contracts in New York, particularly in the financial sector. Delta's management called out New York as one of the two hub markets that saw the biggest unit revenue growth last quarter.

Disciplined CapEx drives tangible benefits

"By maintaining capital discipline and keeping our CapEx at $2.3 billion this year, we should generate over $3 billion in free cash flow. We will use that free cash flow to further improve our balance sheet, and return more cash to shareholders." -- Delta Air Lines CEO Richard Anderson

Among the 3 big U.S. network carriers, Delta produces by far the most free cash flow. By contrast, United Continental and American Airlines are generating virtually no free cash flow. In United's case, the problem is its comparatively low profitability; in American's case, free cash flow is weighed down by the company's massive CapEx budget.

Airline American Airlines Plane Aal

Delta rival American Airlines is not generating much free cash flow (Photo: American Airlines)

Delta's strong free cash flow is allowing it to rapidly pay down debt. Since 2009, Delta has cut its adjusted net debt from more than $17 billion to less than $8 billion. Delta also introduced a dividend last year (currently $0.09 per quarter) and it plans to buy back $2 billion of stock by the end of 2016. Lastly, Delta is contributing $1 billion annually to its pension plan to reduce its pension liability.

Fuel hedging is here to stay

"We also believe in actively managing fuel... Graham Burnett has done a fine job running our fuel organization. This has allowed us to regularly produce quarter after quarter one of the lowest fuel prices in the industry." -- Delta Air Lines CEO Richard Anderson

Delta's top rival, American Airlines, recently closed out the last of its fuel hedges. American's management team is philosophically opposed to fuel hedging, believing that over time, fuel hedging is a money-losing strategy. However, Delta Air Lines remains committed to "actively managing" fuel prices.

In addition to maintaining traditional fuel hedges, Delta also owns a refinery in Pennsylvania. This allows it to hedge against changes in the "crack spread": the price difference between crude oil and jet fuel. While the refinery is only marginally profitable today, Delta is protected from the risk of a surge in refining costs -- something that occurred back in 2012.

Foolish wrap

Delta Air Lines is unique within the U.S. airline industry. Delta's management team hasn't been afraid to go against the industry consensus in recent years. Unusual aspects of Delta's business plan include using older planes, shifting flying back to its mainline operations from regional airlines, and refining its own fuel.

Delta's management remained unapologetic about its unconventional thinking on the recent Q2 conference call. As long as the company continues to post industry-leading profitability and free cash flow metrics, investors aren't likely to complain.

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Adam Levine-Weinberg is short shares of United Continental Holdings. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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