On Wednesday, Delta Air Lines (DAL 2.28%) announced that most of its employees will get a great holiday present this year: a base pay increase averaging 14.5% as of December 1.
Delta is an outlier among large airlines in the U.S., in that it is mostly a non-union company. Delta's pilot group is its only major unionized work group. Having a mostly non-unionized workforce gives Delta lots of flexibility -- including the ability to adjust employee pay without going through a long bargaining process with each union.
Delta's eagerness to provide big raises shows that it wants to keep its non-union employees happy, and thereby make them less likely to unionize in the future. The pay adjustments also point to changes that Delta is looking to make to its union contracts, particularly its pilot agreement, which becomes amendable at the end of this year.
Higher base pay, less profit sharing
Most Delta employees already received an annual raise in April. According to Delta CEO Richard Anderson, "When combined with the April (annual pay) increases, pay rates for most employees will be up 18 percent or more in 2015, providing you with record pay raises in a year of record profits."
Delta will also match employee 401(k) contributions on a dollar-for-dollar basis up to 6% of base pay going forward, compared to matching contributions up to 5% of base pay previously.
However, these pay and retirement benefit increases will be offset partially by a less generous profit sharing formula going forward. In recent years, Delta has paid out 10% of its first $2.5 billion in adjusted pre-tax profit as profit sharing and 20% of its profit above that level. Last year, Delta's profit-sharing expense exceeded $1 billion.
Delta will continue to pay at least 10% of its adjusted pre-tax profit as profit sharing. However, starting with the 2016 profit-sharing payout -- which would be paid in early 2017 -- the higher 20% rate will only apply to profit above the previous year's total.
Given that analysts expect Delta to post an adjusted pre-tax profit of nearly $6 billion (after profit sharing) in 2015, this change in the profit-sharing formula moves the goal posts significantly. Applied across the company, it could potentially reduce Delta's profit-sharing payout by about $500 million just in the first year.
Employees will still come out ahead -- and they will have more security with higher base pay and a smaller profit-sharing payout. But the net pay increase will be significantly less than the widely cited 14.5% figure.
Delta wants a similar deal with its pilots
The compensation change for Delta's non-union employees is very similar to the terms Delta and the Air Line Pilots Association had agreed upon earlier this year for a new pilot contract.
That agreement would have provided an immediate 8% pay raise and a 6% raise in January (together equal to a 14.5% increase in base pay), followed by 3% annual raises in 2017 and 2018. It would have raised the trigger for the 20% profit sharing level to $6 billion in adjusted pre-tax profit, having a similar effect as the new formula for non-union employees. But Delta's pilots rejected the agreement by a 65%-35% margin.
Delta and the pilot union are back in negotiations to come up with an agreement that the rank-and-file pilots will ratify. Delta's move to de-emphasize profit sharing in its non-union employees' compensation packages suggests that changing the profit-sharing formula is a key priority for the airline.
That means Delta may need to offer bigger base pay increases and work rule improvements to appease pilots who were hoping for pay raises and continued high profit-sharing payouts.
As a shareholder, I'm not too worried about Delta giving away the store -- the management team has been very diligent about limiting cost increases recently. Most importantly, Delta is profitable enough today -- and has enough future earnings growth drivers -- that it can absorb a significant increase in employee pay without compromising its profitability.