For more than two years, Delta Air Lines (DAL +1.45%) tried without success to get its unit revenue growing again, after the 2014-2016 oil price crash sparked a price war among U.S. airlines. However, it finally succeeded last quarter, driven by a combination of improving demand and easier year-over-year comparisons.
Delta's return to unit revenue growth also allowed the company to break a streak of margin declines that had stretched for several quarters. Furthermore, the revenue outlook is solid for the foreseeable future. As a result, Delta Air Lines may have just begun a new streak of margin expansion and profit growth.
Delta earnings by the numbers
During the second quarter, Delta Air Lines continued holding down capacity growth to foster a better supply-and-demand balance. This strategy worked. Delta increased capacity just 0.4% year over year, but revenue still increased 3.3%, thanks to a 2.5% increase in passenger revenue per available seat mile (PRASM).
Here are some of the company's other key performance metrics for the recently ended second quarter:
| Metric |
Q2 2017 |
Year-Over-Year Change |
|
Revenue |
$10.79 billion |
3.3% |
|
Adjusted pre-tax income |
$1.85 billion |
10.2% |
|
Adjusted pre-tax margin |
17.2% |
Up 1.1 points |
|
Adjusted EPS |
$1.64 |
11.6% |
|
Passenger unit revenue |
13.94 cents |
2.5% |
|
Adjusted non-fuel unit costs |
10.24 cents |
7.3% |
Data source: Delta Air Lines Q2 earnings release.
The domestic market drives a return to unit revenue growth
Delta Air Lines gets about 70% of its revenue from the domestic market. As a result, domestic unit revenue trends are a key determinant of the company's success.
PRASM began growing again in the domestic market during the second quarter, with a 2.8% year-over-year increase, compared to a 1.4% decline in the prior quarter. PRASM also continued to rebound in the Latin America region, with a 10.8% jump last quarter.
The transatlantic and transpacific markets still remain tough because of overcapacity, along with unfavorable currency fluctuations in some countries. Nevertheless, Delta was able to minimize the damage last quarter, with PRASM declines of about 2% in both of those regions.
Don't fear the cost growth
Delta's non-fuel cost per available seat mile (CASM) surged 7.3% year over year last quarter. Normally, that might have prevented the company from expanding its profit margin. However, economic fuel expense declined significantly relative to Q2 2016, when Delta had incurred big hedging losses.
There were four main components of the sharp increase in non-fuel CASM. First, Delta's new pilot contract wasn't ratified until near the end of 2016. As a result, while its pilots received a big wage increase last year, all of the related costs were incurred in the fourth quarter. If those costs had been spread evenly across the year, then non-fuel CASM would have been up 5.5% in the second quarter.
Non-fuel unit costs surged at Delta last quarter. Image source: Delta Air Lines.
Second, severe storms that hit Atlanta in April and disrupted thousands of Delta flights increased non-fuel CASM by about 1 percentage point. Third, the carrier had an unusually high number of maintenance events last quarter. Fourth, Delta faced "normal" unit cost inflation of about 2%.
The outlook is solid
Looking ahead, Delta expects annual non-fuel CASM growth -- excluding any impact from the timing of last year's pilot wage increase -- to recede to around 2%. The company's fleet renewal initiatives could drive unit cost growth even lower by boosting productivity and reducing maintenance costs.
Meanwhile, the demand environment remains solid. Additionally, Delta Air Lines faces easy year-over-year comparisons this quarter. As a result, management has forecast that PRASM growth will accelerate to 2.5%-4.5% in Q3, leading to a strong operating margin of 18%-20%.
If Delta can maintain this unit revenue momentum coming out of the third quarter, it will be well positioned to deliver double-digit profit growth in the fourth quarter and in 2018.
