Last week, Delta Air Lines (NYSE:DAL) kicked off earnings season for the airline industry by reporting a solid pretax profit (before special items) of $1.72 billion. Nevertheless, its adjusted pretax margin of 15.6% was down significantly relative to Q3 2016, and Delta fell well short of its initial margin forecast for the quarter.
Disruption caused by the numerous natural disasters of the past few months was the main reason why Delta missed its targets last quarter. Rising fuel prices caused additional margin pressure.
Following the earnings report, Delta's top executives spent an hour talking to airline analysts about how the company plans to return to profit growth in 2018. Here are five key points that they highlighted.
1. Unit revenue growth remains the top priority
... [W]e have solid visibility to our path to growing earnings and margins. To get there, first we must keep our unit revenues on a positive trajectory.
-- Delta Air Lines CEO Ed Bastian
During the second quarter, Delta reported unit revenue growth for the first time since 2014. Revenue per available seat mile increased 2.7% in that quarter, and climbed by 2.7% again during Q3.
Year-over-year comparisons will get tougher in the fourth quarter. Nevertheless, management is optimistic about maintaining a healthy rate of unit revenue growth this quarter and into 2018. (For Q4, the company projects that passenger unit revenue will rise 2%-4%.) To that end, Delta will continue to be diligent about keeping capacity growth in line with demand growth.
2. The transatlantic business is finally recovering
Transatlantic had its first positive result in three years, with PRASM increasing 2.4%. ... We expect unit revenue will continue to accelerate further as we head into the historically high strong business season, the fourth quarter.
-- Delta Air Lines President Glen Hauenstein
The transatlantic market is a key bright spot in Delta's efforts to boost unit revenue. Flights to Europe represent a big piece of the carrier's international business. Many of those markets have seen an influx of ultra-low-cost carrier competition, which has weighed on Delta's unit revenue since 2014.
Delta Air Lines is responding by doubling down on the business market, where it has the greatest competitive advantage. Transatlantic business demand is finally benefiting from a rebounding economy in Europe. The strengthening euro represents another tailwind to unit revenue. As a result, Delta expects the transatlantic market to be its strongest region in the fourth quarter.
3. Fleet renewal is about to kick into high gear
In 2018, we will nearly double the pace at which we are replacing older aircraft with more efficient fleet types, and we'll continue to see productivity benefits ramp up. In addition to the network efficiency from a higher gauge, the newer-technology aircraft will also drive efficiency in fuel and maintenance cost benefits.
-- Delta CFO Paul Jacobson
While maintaining a strong unit revenue trajectory is important, Delta Air Lines will also need to keep costs in check to achieve its profit growth goals. Fleet renewal is the company's most important initiative in that regard. By replacing older jets in the 150-seat class with new planes seating 180 or more passengers, Delta can significantly reduce its unit costs.
In recent years, Delta has aggressively ordered end-of-line 737-900ERs and A321s from Boeing and Airbus respectively, as those companies transition to building new models. Deliveries of the A321 in particular are scheduled to ramp up in 2018, allowing Delta to retire older planes at an even faster pace.
4. The transpacific fleet transition represents a huge opportunity
Finally, in the Pacific, the A350 will begin flying later this month, facilitating the last 747 retirements. This will kick off a fleet transition that will allow us to meaningfully enhance our profitability in the region over the next several years.
Delta is also in the midst of a smaller fleet transition project covering its longest routes. The carrier will soon retire its last Boeing 747 jumbo jets. It is replacing them with the A350-900, a plane that is expected to deliver a 20% reduction in per-seat operating costs relative to the 747.
In addition to being cheaper to operate, the A350-900 is likely to generate much better unit revenue results for Delta. First, with 306 seats, it is considerably smaller than the 747-400. This will reduce the number of cheap tickets that Delta will need to sell to fill the plane. Second, the A350-900 will feature an all-suite business class configuration and a new 48-seat "Premium Select" cabin that will give customers an affordable upgrade option.
The combination of lower costs and higher unit revenue on routes served by the new A350 fleet should have a dramatic impact on Delta's profitability in the transpacific market. This region has been the company's Achilles' heel for years on end -- but not for much longer.
5. Big hedging losses are finally coming to an end
For the December quarter, we expect our fuel expense to increase by approximately $250 million. ... This includes a $70 million hedge loss, and I'm happy to say this will be the last quarter impacted by our legacy hedge book.
Rising fuel prices represent an important headwind that Delta will have to manage around in 2018. The spot price of jet fuel is more than $0.10 per gallon higher today than it was in January.
However, at least Delta won't have to deal with big hedging losses going forward. A few years ago, the company made a dubious decision to hedge aggressively against a quick rebound in oil prices. The resulting hedging losses have added to its fuel costs over the past three years. Fortunately, the last of those "legacy" hedges will roll off by year-end, leaving Delta with a clean slate entering 2018.