Like all of its peers in the airline industry, Delta Air Lines (DAL -0.14%) has been hit hard by the COVID-19 pandemic, which has caused air travel demand to collapse. Indeed, the carrier estimates that revenue will plunge roughly 90% year over year in the second quarter. Not surprisingly, Delta is losing money and burning through cash rapidly in this environment.
That said, on Wednesday morning, Delta reported a smaller-than-feared adjusted net loss of $0.51 per share for the first quarter. (On average, analysts were expecting a $0.70 loss.) And while results will get worse in the short term, the airline revealed some important information about proactive moves to cut costs and bolster its liquidity to ensure its survival and eventual recovery.
The downturn begins
For the first two months of the first quarter, COVID-19 was primarily a regional issue in China. The impact on the rest of Delta's route network was relatively limited until March. Nevertheless, March was bad enough to severely impact Delta's results for the quarter.
Back in January, Delta's management projected that revenue would increase 5% to 7% year over year in Q1, while pre-tax margin would remain roughly flat year over year. This implied that adjusted earnings per share would exceed the prior-year result of $0.96.
Instead, Delta's adjusted revenue dipped 17% year over year last quarter, driven by a 13.1% drop in unit revenue. This also fell short of the company's updated forecast from early March. Meanwhile, unit costs inched up slightly, with lower fuel prices not quite offsetting nonfuel cost pressures. This led to the company's $0.51 per share adjusted loss, reported above.
Delta did manage to produce slightly positive operating cash flow of $358 million last quarter, down from $1.94 billion a year earlier. However, it spent nearly $1 billion on capital expenditures and another $2.1 billion for its strategic investment in Latam Airlines (which includes a 20% stake in the carrier and a future joint venture partnership). It also returned $604 million to shareholders through buybacks and dividends in the early part of the quarter.
The net result was that Delta's adjusted net debt jumped from $14.4 billion at the beginning of the first quarter to $17 billion by the end of the period. On the bright side, it ended the quarter with nearly $6 billion of cash and equivalents on its balance sheet, giving it plenty of short-term liquidity.
The second quarter will be far worse
By the end of March, Delta was burning roughly $100 million of cash a day. Net sales turned negative, as refunds outpaced bookings by $10 million to $20 million per day. Meanwhile, most of the airline's costs were locked in last month.
With demand unlikely to begin recovering until the second half of 2020 at best, Delta expects revenue to plunge by about 90% this quarter. This will lead to much bigger losses than what the carrier experienced in the first quarter. Fortunately, Delta has been able to mitigate the losses (and cash burn) by aggressively reducing its costs.
On the expense front, Delta has reduced Q2 capacity by 85%, parked hundreds of aircraft, slashed executive pay, cut employee work hours, encouraged staff to take voluntary unpaid temporary leaves (over a third of its workforce has volunteered), temporarily closed excess airport facilities, and renegotiated contracts. In addition, it plans to defer nearly all of its remaining planned capex for 2020, stretch out payment terms, and delay voluntary pension funding to shore up its cash flow.
Thanks to these efforts, Delta expects costs to decline roughly 50% year over year to $5 billion this quarter. By next month, cash burn should moderate to around $50 million a day. Furthermore, Delta recently received the first tranche of what will total $5.4 billion in payroll support under the CARES Act. Those funds will effectively provide $30 million a day to cover most of Delta's payroll expense for the second and third quarters. (However, 30% of that sum comes in the form of a low-interest loan.)
Between the approximately $4.5 billion of CARES Act funds that will arrive during the second quarter and additional planned financing activities, Delta plans to end the quarter with over $10 billion of cash. While the airline expects to continue burning cash throughout the second half of 2020, this will likely be an adequate level of funding to get through the remainder of the year.
Waiting out the storm
Delta's cash burn is likely to slow gradually in the second half of 2020. However, the pace of improvement will depend largely on how quickly customer demand returns. CEO Ed Bastian warned that a full recovery in demand will likely take at least two or three years.
The good news is that Delta entered the crisis with a better balance sheet than many of its peers. It continues to have plenty of financing options if it needs additional capital. Furthermore, while it will take years to repay the debt being incurred in 2020, Delta may actually exit 2020 with a stronger competitive position in the airline industry as weaker rivals are forced to cut back.
Delta Air Lines remains a risky investment due to the uncertainty about how quickly demand will improve. But with shares sitting nearly 65% below their 52-week high, Delta could have substantial upside for patient investors willing to hold the stock for several years as industry demand and profitability recover.