Last week, Delta Air Lines, (DAL -0.58%) announced a record $1.6 billion adjusted pre-tax profit for Q3. This puts it on pace to earn more than $4 billion before taxes this year, something no airline has done before.
On Thursday morning, Delta executives spoke to analysts and the financial press to discuss the company's strong Q3 results. They painted a rosy picture of Delta's prospects for the next few years. Here are five key points emphasized by the Delta management team.
Domestic upgauging is working
One of our larger cost initiatives this year is the domestic refleeting ... [W]e have generated 2% higher domestic capacity year-to-date on 4.5% fewer departures.
-- Delta CFO Paul Jacobson
In 2012, Delta reached an agreement with its pilots allowing it to expand its fleet of 76-seat regional jets in exchange for also adding 88 Boeing 717 narrowbodies to its mainline fleet. This was part of a broader strategy to reduce unit costs for Delta's domestic operation by retiring most of the fuel-guzzling 50-seat jets operated by its regional partners.
Delta has been adding Boeing 717s to its fleet since last fall (Photo: Delta Air Lines)
This "upgauging" strategy is finally hitting its stride in 2014, and Delta will finish swapping out its 50-seat jets for larger planes in 2015. These larger planes are much cheaper to operate on a per-seat basis. Furthermore, Delta can offer amenities like first class and premium economy seats, Wi-Fi, and larger overhead bins on large regional jets and mainline aircraft.
Between these customer-pleasing amenities and strong domestic demand, Delta has been able to post strong domestic unit revenue growth even as it moves to larger aircraft. Generating more revenue with fewer flights has been a key driver of Delta's margin growth this year.
Ebola isn't hurting demand
Looking ahead to the December quarter, the overall revenue environment remains solid and we expect to produce a 0% to 2% unit revenue gain which combined with a significant decline in fuel prices will lead to continued margin expansion..
-- Delta President Ed Bastian
When the first Ebola case in the U.S. was confirmed in late September, it sparked a panic among many airline investors. The big worry was that people would cut down on air travel due to fear about the spread of Ebola. The more recent news that a nurse who had treated an Ebola patient flew on Frontier Airlines despite having early symptoms of Ebola added to these concerns.
Ebola fears have not dented domestic travel demand so far (Photo: The Motley Fool)
Yet Delta has not noticed any dip in travel demand in the past few weeks. Early bookings for Thanksgiving and the Christmas-New Year's period are both strong. While unit revenue growth is slowing, that has more to do with foreign exchange headwinds on international routes and tough year-over-year comparisons more generally.
Bye-bye to the big birds
We've already retired three [Boeing 747s] in September and another one this quarter. Four more will be retired in 2015, and the remainder will exit the fleet by 2017. These retirements will be margin accretive and are expected to generate $100 million next year in operating contribution.
-- Delta CEO Richard Anderson
Delta's management has made it clear for a while that they don't like jumbo jets. Smaller widebodies with two engines are typically more fuel-efficient, and it's easier to fill them with customers without offering big discounts.
However, Delta inherited a fleet of Boeing 747s from Northwest, and Delta typically tries to squeeze as much life out of its planes as possible. In this case, the growing supply demand imbalance in international markets pushed Delta to accelerate the retirement of its 16 Boeing 747s.
By cutting back on intra-Asia flights -- mainly between Tokyo and other cities in Asia -- and moving from 747s to smaller aircraft (mostly A330s), Delta expects to boost its earnings by $100 million next year. As Delta continues to retire 747s in the next few years, its savings should increase.
Domestic growth in Seattle is paying off
Seattle's domestic performance has significantly exceeded our expectations as unit revenues increased 6% on a 25% increase in capacity driving margin improvements year-over-year.
-- Delta President Ed Bastian
Delta has been building a major international gateway in Seattle recently. In the past two years, it has added new flights to Shanghai, London, Seoul, and Hong Kong. Initially, it mainly relied upon Alaska Air to provide connecting traffic. However, this year it has started to build out its own domestic network in Seattle.
Delta is successfully competing with Alaska Airlines in Seattle (Photo: The Motley Fool)
Considering how entrenched Alaska is in Seattle, this was a risky move. However, it has worked out brilliantly. Delta was able to boost its domestic unit revenue in Seattle despite significantly growing its capacity there, while also reducing its reliance on Alaska Airlines for connecting traffic.
The refinery is starting to crank out profits
The refinery made a $19 million profit for the quarter, which lowered our fuel price by $0.02 per gallon.
-- Delta CFO Paul Jacobson
Delta has attracted plenty of criticism in the last couple of years for purchasing an oil refinery. Many airline and refinery industry experts questioned the wisdom of an airline operating a refinery as soon as the deal was announced. The refinery has produced several quarterly losses for Delta in the past two years, providing further ammunition for critics.
However, Delta bought the Trainer refinery to hedge against changes in the crack spread (the price difference between crude oil and jet fuel). The refinery has been losing money for most of the past two years because the jet fuel crack spread had narrowed. This wasn't a problem, though, because Delta's refinery losses were offset by lower jet fuel prices.
By contrast, crack spreads have started to widen again, and Delta is now reaping the benefit of its refinery. The refinery made a $19 million profit last quarter, and it is expected to earn about $20 million in Q4. Delta's refinery profitability is also being helped by its increased usage of cheaper domestic crude oil.
Delta keeps rolling
In the past 2-3 years, Delta has laid out a number of strategies to improve its profitability, return on invested capital, and free cash flow. So far, those strategies have worked just as advertised, propelling Delta to the top of the airline industry across many metrics of performance.
Based on the business trends and plans highlighted by Delta's management last week, it looks like the company is on track for further gains next year. Shareholders can just sit back and enjoy the ride.
