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Delta Air Lines, Inc. Management Takes a Victory Lap

By Adam Levine-Weinberg – Oct 17, 2018 at 2:35PM

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Despite surging fuel prices, Delta Air Lines is on track to deliver another year of strong earnings in 2018 -- and the 2019 outlook is even better.

Delta Air Lines' (DAL 1.82%) third-quarter earnings report -- released last week -- showed that adjusted pre-tax margin continued to decline, as fuel prices are still rising quickly. Delta wasn't quite able to offset the impact of higher fuel costs, although adjusted earnings per share still jumped 16.9%, primarily due to the benefit from federal tax reform.

But looking ahead, Delta Air Lines does expect to stabilize its adjusted pre-tax profit margin in Q4. Moreover, management expects a return to margin expansion in 2019. As a result, the company's recent earnings call turned into a somewhat of a victory lap for Delta executives. Here are some of the highlights they focused on.

Earnings power stays strong in the face of adversity

Despite three significant upward moves in fuel this year, driving more than $2 billion of higher fuel expense, we still expect to deliver our fourth consecutive year of pre-tax profits over $5 billion.
-- CEO Ed Bastian

Delta Air Lines CEO Ed Bastian started the call by highlighting how the carrier has managed to avoid a sharp drop in its pre-tax earnings this year despite soaring fuel costs.

A Delta Air Lines plane

Image source: Delta Air Lines.

Indeed, adjusted pre-tax profit is on track to exceed $5 billion for a fourth consecutive year. Fuel prices (not to mention labor costs) were lower for much of the previous three years. Bastian noted that Delta can now recover fuel price increases through higher unit revenue more quickly than it could in the past. As a result, he is confident that Delta will surpass $5 billion in pre-tax profit again in 2019, even if fuel prices keep rising.

Demand for Delta's product is very strong

The revenue environment is the best we've seen in years and the Delta brand has never been stronger.
-- President Glen Hauenstein

Delta posted a 4.3% increase in revenue per available seat mile (RASM) last quarter and expects RASM to rise 3% to 5% in the fourth quarter. Strong U.S. GDP growth is certainly a key factor enabling this revenue momentum.

However, Delta's own initiatives also deserve a lot of credit. Expanding the number of premium seats available and providing more ways to purchase or upgrade to those seats are particularly important priorities for Delta.

Last quarter, premium seat revenue surged 19% with just a 3% increase in premium seats. In the next few years, premium seat inventory is likely to expand even faster, as Delta retires older MD-88s and 50-seat regional jets and replaces them with new planes that have bigger first-class cabins and more extra-legroom seats. The ongoing rollout of Delta's extremely popular Premium Select cabin on international routes will also be a big driver of premium seat revenue growth.

Of course, getting the basics right is important, too. Fortunately, Delta's excellent reliability and consistent customer service have boosted customer satisfaction levels to record highs.

Cost trends are right where Delta wants them

While non-fuel cost[s] in the first half of the year were slightly higher than we expected, non-fuel unit costs were flat for the September quarter. This is a three-point improvement from the June quarter.
-- CFO Paul Jacobson

For most of the last few years, labor cost pressure has prevented Delta Air Lines from meeting its goal of limiting annual non-fuel unit cost increases to a maximum of 2%. However, Delta has also turned the corner on this side of the ledger. Non-fuel unit costs came in flat year over year last quarter and are expected to be flat to down 1% in the fourth quarter.

Management is confident that the company can keep non-fuel unit cost growth below 2% going forward even though it continues to raise its employees' wages. Delta's aggressive fleet renewal plan will play a big role in this regard, as the carrier is steadily "upgauging" to larger aircraft that have lower unit costs. Delta is also making progress on a variety of other efficiency projects.

The combination of strong revenue momentum and slowing non-fuel unit cost growth lends credence to management's assertion that Delta Air Lines will be able to expand its pre-tax margin next year, even with oil prices near a multiyear high. In that context, one can hardly blame Delta's leaders for taking a moment to congratulate themselves and the rest of their colleagues.

Adam Levine-Weinberg owns shares of Delta Air Lines. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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