Delta Air Lines (DAL +2.63%) has been one of the steadiest performers in the airline industry since the Great Recession ended. Yet it has still faced plenty of challenges, with unit revenue repeatedly falling short of management's expectations recently.
However, Delta finally conquered its unit-revenue weakness last quarter. As a result, it's set to report strong second-quarter results on Thursday morning. Furthermore, earnings growth is likely to accelerate in the second half of 2017. This could spark a rally in Delta Air Lines stock in the coming months.
Delta's investor update looks good
Last week, Delta Air Lines gave investors a sneak peek at its second-quarter results. The company estimates that passenger revenue per available seat mile (PRASM) rose about 2.5% year over year last quarter. Additionally, Delta's economic fuel costs declined to approximately $1.68-$1.73/gallon last quarter, down from $1.97/gallon a year earlier. (Delta's Q2 2016 fuel costs were driven up by losses related to closing out fuel-hedging positions.)
Delta's unit revenue is finally rising again. Image source: Delta Air Lines.
On the flip side, non-fuel unit costs likely increased by 5%-6% year over year last quarter, driven primarily by rising maintenance costs.
Nevertheless, between its return to unit revenue growth and lower economic fuel costs, Delta Air Lines is set to report a return to margin expansion in Q2. The company's current guidance implies that its pre-tax margin will be roughly 17%-18%, which would be a record result for the second quarter.
Good trends and easy comparisons
With many airlines struggling to keep unit revenue growing in recent years, investors have been very focused on unit revenue when evaluating airlines' financial performance. From this perspective, Delta Air Lines is likely to provide a favorable outlook on Thursday.
Unit-revenue trends have been moving in the right direction during 2017. Delta's PRASM rose 3.5% in May and 2.5% in June, after increasing just 1% in April and declining 0.5% year over year during the first quarter. This solid trend bodes well for the company's unit-revenue performance in the next few quarters, especially over the summer.
Additionally, Delta Air Lines will face some very easy unit-revenue comparisons this summer. The company estimated that PRASM plunged 7% year over year in July 2016 and 9.5% in August 2016, which marked the trough of Delta's unit-revenue performance. As a result, Delta's PRASM growth is likely to accelerate this quarter relative to Q2.
Cost performance is set to improve
Delta Air Lines' unit-cost performance is also likely to improve going forward. CFO Paul Jacobson has stated on several occasions that non-fuel unit-cost inflation will subside to 2% or less in the second half of 2017. Fuel costs are also set to remain low by historical standards for the foreseeable future.
Looking further ahead, Delta plans to replace about 25% of its mainline fleet by 2020. A big piece of this fleet modernization will entail replacing 149-seat MD-88s with larger 737-900ERs and A321s. This will help to contain unit-cost growth by boosting productivity.
Delta is adding lots of A321s to its fleet, which will hold down unit costs. Image source: Delta Air LInes.
Delta's fleet-modernization project will also significantly reduce the average age of its fleet. This should drive down maintenance costs, because brand new planes usually don't need much maintenance work for the first few years that they're in service.
Can Delta avoid any surprises?
Thus, Delta Air Lines appears to be on track to report accelerating profit growth in the next few quarters, as unit-revenue growth strengthens while unit costs stay under control. However, Delta has experienced some "false starts" in the recent past, with unit-revenue trends improving for a few months before abruptly reversing.
This mixed track record probably explains why Delta stock currently trades for just 10 times earnings. If the company can avoid any negative surprises in its next few quarterly reports, investors may gain confidence in the company's long-term earnings power, driving Delta shares significantly higher.
