Delta Air Lines (NYSE:DAL) will release its Q3 earnings report on Wednesday, and the company is on pace to produce a record adjusted profit for the busy summer quarter. With Delta having updated its financial guidance earlier this month, there isn't much suspense about its Q3 performance.
However, shareholders are anxiously waiting to see what financial guidance Delta will provide for Q4. The carrier has suggested that its unit revenue trajectory will start to improve this quarter. Delta probably needs to provide a clear road map for a return to unit revenue growth to get investors excited about the stock again.
Delta narrows its guidance
On Oct. 2, Delta released an investor update narrowing its Q3 operating margin guidance range to 20%-21%, the upper half of the original range. While passenger revenue per available seat mile, or PRASM, declined 4.5%-5.5% in the quarter, that was also in the more favorable half of the original guidance range. Fuel costs also came in lower than expected.
As long as Delta's recent estimates were reasonably accurate, its Q3 revenue and earnings per share aren't likely to surprise anyone. Analysts have tweaked their estimates since the investor update and now expect Delta to earn $1.72 per share on revenue of $11.1 billion.
Delta needs to address its unit revenue weakness
Like other airlines exposed to the international market, Delta's PRASM has been under pressure all year. Back in April, management announced that it would address this matter by implementing significant international capacity cuts in the fall. In total, the airline cut its fourth-quarter international capacity plan by 6 percentage points, calling for a 3% year-over-year decline rather than a 3% increase.
By slashing capacity by 15%-20% in weak markets like Africa, India, the Middle East, and Japan -- and dropping service to Moscow entirely during the winter season -- Delta aimed to stabilize its unit revenue.
The international market continued to underperform during the second quarter, though. As a result, Delta scaled back its fourth quarter capacity plans again. As of July, the company planned to reduce Q4 international capacity by 3.5%.
Delta President Ed Bastian stated on the Q2 earnings call that these actions should get "unit revenue to be roughly flat by year end." He later clarified that this didn't mean unit revenue would be flat in Q4. Instead, the goal is to reach the flat line by the end of the quarter, setting the stage for a return to unit revenue growth in 2016.
The outlook is the key
Because of the uncertain revenue climate, investors should focus their attention on Delta's outlook for Q4 as well as any management commentary about plans for 2016. Delta is likely to post a low single-digit unit revenue decline this quarter, but the guidance will be a lot more comforting if it calls for a 1%-3% PRASM decline rather than a 2%-4% decline (or worse).
It will also be interesting to see if Delta is still planning to reduce international capacity by 3.5% this quarter. The further Delta seems to be from its stated goal of flat unit revenue by year-end, the more important it will be to see the company continuing to prune underperforming routes.
Finally, investors should listen closely to management's commentary on the earnings call for any details about capacity plans or revenue trends for 2016. It's quite possible that Delta executives will refuse to discuss 2016 projections. Nevertheless, any hints on whether the carrier is already on track to return to unit revenue growth next year or whether more capacity cuts might be needed could provide meaningful insight about Delta's future trajectory.
Adam Levine-Weinberg is long January 2017 $40 calls on Delta Air Lines, The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.