In the second quarter of 2021, most U.S. airlines turned profitable for the first time since the COVID-19 pandemic began in early 2020. However, they relied on a big dose of government payroll-support grants to reach that milestone.
On Wednesday, Delta Air Lines (DAL -3.90%) reported a profit for the third quarter, even after excluding its payroll-support income. The strong improvement in Delta's underlying results bodes well for its continued recovery over the next couple of years.
Delta delivers an adjusted profit
Three months ago, Delta Air Lines predicted that it would post a solid profit in the third quarter. While the carrier expected total revenue to decline 30% to 35%, compared to Q3 2019, it also planned to reduce capacity by as much as 30%. Thus, its initial guidance implied that unit revenue would nearly recover to 2019 levels.
Like most of its peers, Delta reduced its guidance in early September, noting that the latest wave of the COVID-19 pandemic had sapped demand and caused the nascent recovery in business travel to pause. That said, the company still projected that it would post an adjusted profit.
Delta followed through on its updated guidance. Excluding special items, revenue declined 34% relative to the third quarter of 2019 -- slightly better than the low end of the company's initial guidance for a 30% to 35% decline on that basis. Adjusted nonfuel unit costs rose 15% from Q3 2019, mainly due to recovery-related costs like maintenance and training. That matched its September forecast. On the flip side, adjusted fuel costs ticked down to $1.94 per gallon.
This enabled Delta Air Lines to record an adjusted pre-tax profit of $216 million and adjusted earnings per share (EPS) of $0.30. That beat the average analyst estimate of $0.17. The company also generated positive operating cash flow despite seasonal headwinds related to the timing of ticket sales.
Including the benefit from federal payroll support grants, Delta posted a sizable pre-tax profit of $1.5 billion and EPS of $1.89: down just 18% from two years earlier.
Two encouraging trends
While Delta Air Lines' Q3 results fell a bit short of its initial expectations for the quarter, the demand environment stabilized last month. Additionally, two key bright spots in the quarterly report should give investors confidence about the future.
First, Delta received just over $1 billion of remuneration from credit card partner American Express last quarter, up 1% from Q3 2019. Spending on Delta co-branded AmEx cards has reached record levels, and the pace of new cardmember signups is approaching pre-pandemic levels. As travel demand continues to recover and improved deal terms kick in between now and 2023, this high-margin revenue source looks set to return to its pre-pandemic growth trajectory.
Second, premium-cabin revenue continued to recover faster than main-cabin revenue on short-haul routes. While business-travel volumes remain well below 2019 levels, a growing number of wealthy leisure travelers have been willing to pay extra for premium seating options. As business travel rebounds over the next year or two, it will bolster demand for premium seats, helping Delta grow its unit revenue.
For the fourth quarter, Delta expects another sequential improvement in revenue as capacity reaches 80% of pre-pandemic levels. Meanwhile, nonfuel unit costs should rise just 6% to 8% compared to Q4 2019, marking a big improvement over the third quarter.
Nevertheless, management warned that soaring fuel prices will make it tough for Delta to log another profit this quarter. Indeed, the price of Brent crude oil has jumped by about $10 per barrel over the past month. Jet-fuel prices have risen at an even faster rate. So far, OPEC and its allies have resisted calls to raise production targets, keeping oil prices on an upward trajectory.
Analysts had expected Delta to earn $0.33 per share in the fourth quarter. As a result, the carrier's warning about near-term profitability spooked some investors, causing Delta Air Lines stock to sink nearly 6% on Wednesday.
This looks like an overreaction. Oil prices can be extremely volatile, and there's no reason to believe the current price spike will last especially long.
In any case, Delta has proven over the past decade that it can generate high profits regardless of the level of fuel prices. It just takes a little while to pass cost increases through to customers. Considering the airline's solid underlying revenue and cost trends, the current dip could be a great opportunity for patient investors to buy Delta Air Lines stock.