For more than two years, executives at Delta Air Lines (NYSE:DAL) have been talking about an imminent return to unit revenue growth. However, until recently, the carrier's efforts to get unit revenue back on track had all fallen short.
Fortunately, Delta is on pace to report solid unit revenue growth this quarter, despite a damaging operational disruption in early April related to waves of severe thunderstorms in Atlanta. With more revenue growth initiatives slated to kick in later this year, Delta Air Lines stock may finally be ready to take off again.
A history of missed targets
A few years ago, Delta had a reputation among investors for being very reliable. It routinely met or exceeded its financial guidance and posted strong unit revenue growth. This helped Delta Air Lines stock soar from below $10 in late 2012 to around $50 by early 2015.
Yet even Delta's management wasn't prepared for the disruptive combination of falling fuel prices, the strong dollar, and rising low-cost carrier capacity that impacted airline industry unit revenue beginning in late 2014.
When oil prices began to fall in late 2014, Delta's management initially didn't expect it to impact unit revenue. After unit revenue began to decline, the company took action in early 2015 to stabilize passenger revenue per available seat mile (PRASM) by year-end. Delta's unit revenue trajectory did improve by the fourth quarter of that year, but it then took a turn for the worse in early 2016.
Delta Air Lines' most recent unit revenue disappointment occurred last quarter. In January, Delta projected that PRASM would rise 0%-2% in the first quarter. Ultimately, PRASM declined 0.5% in the first quarter.
Finally, signs of improvement
While Delta's first-quarter unit revenue performance was disappointing, at least the company has become more proactive about returning to unit revenue growth recently. Last December, Delta announced that it would limit capacity growth to 1% until unit revenue returned to steady growth.
This capacity discipline seems to be working. Delta's PRASM rose 1% in April, despite the storm impact, which reduced pre-tax profit by about $125 million. Last week, the carrier reported that PRASM increased by about 3.5% in May.
This puts Delta solidly on track to meet its guidance for 1%-3% PRASM growth in the second quarter. That would be its first quarterly unit revenue increase since 2014. Delta's strong May performance is particularly encouraging because it reflects strong underlying demand rather than calendar effects. (By contrast, many other airlines posted strong unit revenue growth in April primarily due to the timing of Easter.)
Will unit revenue growth continue?
Looking toward the second half of 2017 and beyond, several unit revenue growth drivers are set to kick in for Delta Air Lines. First, it continues to expand the availability of extra-legroom "Comfort+" seats. It has added Comfort+ seats on many 50-seat jets that just had regular economy seats before. Delta also recently made it easier to buy Comfort+ fares on many international flights.
Second, Delta Air Lines will roll out its first premium economy sections later this year on its new A350 long-haul jets. Delta's "Premium Select" seats will be wider than standard economy seats in addition to offering more legroom. Customers in Premium Select will also be entitled to a variety of other upgraded amenities.
By offering more gradations of service, Delta will be better able to segment demand. For example, travelers who weren't willing to pay to upgrade to Delta One (Delta's business class product) might be willing to pay a smaller amount to upgrade to Premium Select. And business travelers will appreciate being able to upgrade to slightly roomier seats on Delta's smallest regional planes.
These initiatives should help Delta continue posting solid unit revenue growth -- at least if overall demand remains healthy and Delta remains cautious about capacity growth. If Delta does manage to maintain its unit revenue momentum in the second half of the year, it could be the catalyst that sets off another rally in Delta Air Lines stock.