Three months ago, Delta Air Lines (DAL +0.12%) reported strong earnings growth for the second quarter and projected that earnings would continue to rise in the third and fourth quarters.
However, Delta announced on Wednesday morning that adjusted earnings per share fell by 7.6% in the third quarter. A combination of rising fuel prices, ongoing softness in fares for last-minute bookings, and flight cancellations due to major hurricanes caused the company to fall well short of its original forecast. Nevertheless, Delta is quickly getting back on track. As a result, management expects a return to strong earnings growth in 2018.
Delta earnings by the numbers
While Delta faced significant revenue and cost headwinds last quarter, it still managed to earn a $1.72 billion adjusted pretax profit. That's a huge sum by airline standards. Here are some of Delta's other key performance metrics for the third quarter:
| Metric |
Q3 2017 |
Year-Over-Year Change |
|---|---|---|
|
Revenue |
$11.06 billion |
5.5% |
|
Adjusted pretax income |
$1.72 billion |
(9.5%) |
|
Adjusted pretax margin |
15.6% |
Down 2.6 points |
|
Adjusted EPS |
$1.57 |
(7.6%) |
|
Total airline unit revenue |
15.58 cents |
2.7% |
|
Adjusted nonfuel unit costs |
10.05 cents |
4.8% |
Data source: Delta Air Lines Q3 earnings release.
After holding capacity roughly flat in the first half of 2017, Delta modestly increased its capacity in the third quarter. Despite the additional supply, revenue per available seat mile (RASM) rose by a solid 2.7% year over year. The Latin America region remained especially strong, with passenger unit revenue up 5.9%. RASM also benefited from a double-digit increase in cargo revenue and a huge jump in revenue from the Delta SkyMiles loyalty program.
The net result was that Delta's revenue rose 5.5% year over year. That's the strongest revenue growth it has reported in several years. However, costs rose even faster, due to a steep rise in oil prices during the quarter and the disruption caused by Hurricane Irma in particular. Thus, adjusted EPS declined to $1.57 from $1.70 a year earlier.
Why Delta missed its guidance
Back in July, management forecast that Delta Air Lines' operating margin would reach 18%-20% for the third quarter. However, it ultimately came in around 16%.
Delta Air Lines missed its original margin guidance for Q3. Image source: Delta Air Lines.
First, the uptick in oil prices since July caused third-quarter economic fuel costs to be about $0.10 per gallon higher than expected. Second, Hurricane Irma forced Delta to cancel thousands of flights, which negatively impacted operating income by about $120 million. Together, these two factors reduced Delta's Q3 operating margin by 2 percentage points. Adjusting for these impacts, Delta Air Lines probably would have reached the lower bound of its margin guidance.
A tough competitive environment also contributed to Delta's weaker-than-expected profitability. The carrier has been working to boost fares for last-minute business travel, but discounting by rivals has complicated those efforts.
Better times ahead
Delta's fourth-quarter guidance calls for a solid 2%-4% year-over-year increase in passenger unit revenue. Nevertheless, profitability is likely to remain under pressure due to cost inflation.
Delta Air Lines expects normalized nonfuel unit costs to rise by 4%-5%, driven by a recent change in its profit sharing program. (Delta recently moved its nonpilot employees back to the pilots' more generous profit-sharing plan.) Meanwhile, economic fuel costs are on track to be about $0.25 per gallon higher this quarter relative to the prior-year period.
On the bright side, nonfuel cost pressure should quickly recede in 2018, as Delta starts to benefit from its latest round of fleet renewal. If Delta Air Lines' revenue growth initiatives keep RASM rising at a steady pace, the company should be able to return to earnings growth next year.
