Delta Air Lines, Inc. Q2 Earnings: Solid Profitability Despite Soaring Costs

After several years of unit revenue declines, Delta Air Lines (DAL -2.62%) finally got revenue per available seat mile (RASM) rising again in 2017. By year-end, Delta's growing revenue momentum gave management confidence in the company's ability to achieve margin expansion in 2018.

Unfortunately, rising fuel prices have thrown a wrench into the company's margin expansion plans. On Thursday, Delta Air Lines reported that its adjusted pre-tax margin fell by nearly 3 percentage points last quarter, despite strong revenue growth. Nevertheless, Delta remains one of the more profitable airlines and is putting itself in position to return to margin expansion in 2019.

Delta earnings by the numbers

Delta's revenue momentum continues to accelerate, due to strong travel demand and the airline's efforts to boost fares to offset higher fuel costs. However, costs are rising even faster.

Data source: Delta Air Lines Q2 earnings release. YOY = year over year. 

Last quarter, revenue surged 9.6% year over year to $11.78 billion. (If you exclude refinery-related sales and zero in on the core airline operations, revenue rose 8.2%.) RASM rose 4.6%, down slightly from Delta's 5% first-quarter RASM gain.

Meanwhile, non-fuel unit costs crept up 2.9%, driven by higher selling costs and an increase in aircraft rent and depreciation expense related to Delta's fleet renewal plan. Of course, the biggest drag on earnings came from rising fuel costs. Delta Air Lines paid $2.17 per gallon for jet fuel last quarter (adjusted for hedging activity), up from $1.66 per gallon a year earlier. This increase in Delta's fuel bill more than offset its RASM growth.

The net result was that Delta's adjusted pre-tax margin fell to 13.9% from 16.8% a year earlier, while adjusted pre-tax income slipped 10.2% to $1.61 billion. However, Delta still posted a double-digit increase in earnings per share, due to the benefit of tax reform. Adjusted EPS of $1.77 surpassed Delta's updated forecast range of $1.65 to $1.75. The upside came from fuel costs increasing somewhat less than previously expected.

Delta beat its updated EPS guidance for the second quarter. Image source: Delta Air Lines.

Full-year guidance comes down

In conjunction with its second-quarter earnings report, Delta Air Lines slashed its 2018 EPS forecast. Back in January, following the tax reform announcement, Delta projected that it would generate EPS of $6.35 to $6.70 this year. On Wednesday, the company reduced its EPS forecast range to $5.35 to $5.70.

Delta blamed the guidance cut on a $2 billion increase in its projected 2018 fuel bill. Indeed, the market price of jet fuel spiked from $1.90 per gallon at the beginning of the year to $2.20 per gallon by mid-May, before falling to $2.15 per gallon as of Monday.

The $1 reduction in Delta's EPS guidance implies that pre-tax profit will be about $900 million lower than initially expected. In other words, the carrier expects to recapture more than half of the increase in its fuel costs during 2018.

The future is bright

Delta Air Lines expects to maintain its strong unit revenue trajectory in the third quarter, with RASM up 3.5% to 5.5% year over year. Additionally, non-fuel unit costs will be roughly flat, following higher-than-expected increases in the first half of 2018.

Delta still expects that its adjusted pre-tax margin will slip from 15.6% in Q3 2017 to a range of 12% to 14% this quarter. This assumes an average fuel price as high as $2.37 per gallon. That said, oil prices have plunged about 7% in the past few days, which could provide some fuel cost relief.

In any case, investors were already expecting Delta to fall short of its previous EPS forecast, so the guidance reduction was fairly anticlimactic. The carrier also revealed that it will cut some underperforming flights this fall to bolster its profitability. If Delta Air Lines can keep growing unit revenue at a mid-single-digit rate in late 2018 and 2019, it should be able to fully offset its rising fuel costs and return to margin expansion sooner or later.