The U.S. airline industry has faced lots of turbulence in 2019, with the grounding of the Boeing 737 MAX, delivery delays for Airbus A321neos, and overcapacity in certain regions tripping up many of the top airlines. Throughout the year, Delta Air Lines (DAL 3.42%) has stood out for its consistently strong performance -- partly because it hasn't ordered the 737 MAX and has no scheduled A321neo deliveries until next year.
That streak continued last quarter. On Wednesday morning, Delta narrowed and reaffirmed its earnings guidance for the third quarter. This keeps the company on track to finish the year with strong earnings growth.
Q3 tracking mostly as expected
Three months ago, Delta Air Lines projected that revenue per available seat mile (RASM) would rise 1.5% to 3.5% in the third quarter, outpacing a 1% to 2% increase in adjusted nonfuel unit costs. The carrier also estimated that its average fuel price would fall to a range of $1.95 to $2.15 per gallon, compared to $2.22 per gallon a year earlier.
Based on this outlook, management forecast that Delta's pre-tax margin would reach a range of 14.5% to 16.5% and adjusted earnings per share would come in between $2.10 and $2.40. In Q3 2018, Delta reported an adjusted pre-tax margin of 13.5% and adjusted EPS of $1.80.
In the update released on Wednesday, Delta Air Lines said that RASM rose about 2.5% last quarter: right in the middle of its previous guidance range. Record load factors (the percentage of seats filled with paying customers) and rising non-ticket revenue -- primarily from Delta's successful credit card partnership with American Express (AXP 2.05%) -- drove most of the RASM increase.
Delta reported strong RASM growth for the third quarter. Image source: Delta Air Lines.
Adjusted nonfuel unit costs also rose about 2.5%. Management attributed this worse-than-expected result to higher employee costs, record passenger traffic, and the impact of severe weather. On the flip side, Delta's average fuel price will land between $1.95 and $2.05 per gallon, offsetting the increase in nonfuel costs. The net result is that Delta expects to report an adjusted pre-tax margin of approximately 15.5% and adjusted EPS between $2.20 and $2.30, hitting the midpoint of its original forecast.
The early outlook for Q4 is mostly favorable
While Delta hasn't provided guidance for the fourth quarter yet, revenue trends are likely to remain solid as the continued grounding of the 737 MAX keeps a lid on industry capacity. New short-term bonus offers being offered by American Express this month could also boost signups for Delta's co-branded credit cards, driving growth in non-ticket revenue.
On the cost side, Delta warned that it expects to face pressure on nonfuel unit costs in the fourth quarter. Recently announced wage increases for non-union employees, the timing of maintenance expenses, and changes to actuarial assumptions affecting pension and other postretirement costs will all contribute to unit cost growth. Based on Delta's updated full-year cost guidance, it looks like nonfuel unit costs may increase 4% to 5% this quarter.
Fortunately, a spike in oil prices following attacks on Saudi infrastructure has fully reversed itself in recent weeks. That means Delta is likely to pay about $2.00 per gallon for jet fuel again this quarter, which would be down significantly from $2.42 per gallon in the prior-year period.
Lower fuel costs should thus more than offset Delta's nonfuel cost pressure in the fourth quarter. As a result, analysts' projections that adjusted EPS will rise 20% to $1.56 in Q4 and surge 26% to $7.13 for the full year seem conservative, if anything.
Delta is building a sustainable business
As of 1:15 p.m. EDT on Wednesday, Delta Air Lines stock had fallen 6% due to its investor update. Clearly, investors were worried about the prospect of higher nonfuel unit costs. However, most of the cost headwinds the company is citing are short-term in nature. Delta has numerous cost reduction initiatives under way, which should boost productivity and drive better cost performance in 2020.
Meanwhile, Delta has done an admirable job of diversifying its revenue base away from commoditized economy-class tickets. Most notably, premium products accounted for 31% of Delta's revenue last year, up from 18% in 2011. Delta's loyalty program -- and primarily the AmEx partnership -- contributed another 9% of the carrier's revenue, up from 5% in 2011.
Earlier this year, Delta projected that revenue from the American Express partnership would double between 2018 and 2023, reaching $7 billion by the end of that period. AmEx is "relaunching" the Delta credit cards early next year, with new schemes that will help cardholders earn miles faster. This will help drive the loyalty program growth that the airline is counting on.
In short, the outlook for Delta remains rock-solid. Moreover, the stock trades for just eight times earnings. That makes the recent dip in the share price an excellent buying opportunity for long-term investors.
