Delta (DAL) Stock: How Big is Its Fuel Advantage?

Delta claims a big fuel advantage over rivals. How real is it? Credit: The Motley Fool.

Delta Air Lines (DAL 4.05%) made headlines when it purchased the Trainer refinery in Delaware from Phillips 66 in 2012. At the time, executives pitched the $180 million purchase as a way to control most of its out-of-pocket fuel costs.

As Delta President and board member Ed Bastian put it at the Bank of America Merrill Lynch Global Transportation Conference in May 2012:

"We're doing [the transformation of the Trainer refinery] in concert with a couple of strategic partners. We get questions a lot, as to, "Well, if you thought a refinery was a good idea, why didn't you go in partnership with somebody to help defray the cost or bring some added expertise to the table?" The reality is, we did that, and we've got long-term agreements together with BP plc as well as Conoco -- Phillips 66. They are going to take all the output of the plant that we don't need, which will be the gasoline products, the diesel products and some of the chemical products, and swap those in return for jet fuel in other parts of the country so that this one facility will result in us being able to supply 80%, 8-0 percent, of our jet fuel needs across the U.S. airline."

That's a bold claim, which we can document and monitor thanks to the transcribers at S&P Capital IQ. How has strategy played out so far? Delta CFO Paul Jacobson told analysts listening in on the company's latest earnings call that the Trainer refinery added $19 million in profit during the third quarter, lowering Delta's fuel costs by $0.02 a gallon.

Minding the fuel cost gap
Even a couple of pennies adds up when you're using millions of gallons of fuel. In the third quarter alone, Delta aircraft burned some 1.067 billion gallons flying passengers around the globe. American Airlines Group (AAL 1.51%) burned 1.130 billion gallons over the same period, while United Continental (UAL 1.59%) aircraft consumed 1.037 billion gallons.

All three consume about the same fuel and compete for business among the same general pool of business and consumer travelers. Does Delta's aggressive fuel hedging amount to an advantage in the fight for profits? Apparently so, judging by what carriers say are their bottom-line per-gallon fuel costs in each of the last four quarters:

Sources: American, Delta, and United press releases.

To be fair, neither American nor United list the sorts of "mark-to-market" adjustments that are included in Delta's calculations. They are comprehensive, however, in that they account for cash settlements on hedges, which makes this about as fair a comparison as I can come up with. It's also consistent with comments from Jacobson.

Here's a partial transcript of his comments at the Goldman Sachs Industrials Conference held earlier this month, with transcribing once again provided by S&P Capital IQ:

Fuel price is looking at a $0.05 to $0.10 advantage, $0.05 to $0.10 per gallon for Delta is a meaningful, meaningful performance. We are geared about $40 million in annual fuel expense for every penny difference. So this represents a sizable opportunity for Delta to outperform.

The trick, of course, is cashing in on that advantage consistently. In the third quarter, Delta reversed course by posting a 3.2% operating margin versus 8.5% for American and 8.7% for United, according to S&P Capital IQ. Thats not necessarily an indicator of bad times to come. If it says anything about Delta's business, it's that the refinery -- for all the good it's doing so far -- doesn't yet amount to a sustainable competitive advantage.