Delta Air Lines (NYSE:DAL) led off earnings season for the airline industry on Wednesday with a stellar quarterly report. While the company hasn't been immune to the shaky unit revenue environment in 2015, it was able to post strong profit growth in Q3, thanks to the benefit of lower fuel prices.
Let's take a more detailed look at how Delta produced a record quarterly profit.
Behind the scenes
Earlier this month, Delta updated its third-quarter guidance, calling for its operating margin to reach the upper half of its original 19%-21% guidance range. The company delivered, with its Q3 operating margin hitting the very top of the range, at 21%.
Adjusted earnings per share for the quarter soared more than 40% year over year to $1.74, slightly ahead of the average analyst estimate of $1.71. Delta's revenue declined modestly (less than 1%) to $11.11 billion, roughly matching analysts' expectations.
Passenger unit revenue -- which is an important metric because it only includes revenue from tickets and frequent-flier mile sales, and strips out changes in capacity -- declined 4.9% in Q3. That was slightly better than the midpoint of Delta's updated guidance, which had projected a 4.5%-5.5% decline.
As has typically been the case this year, the domestic market dramatically outperformed international routes, which have been hurt by the strong dollar and falling fuel surcharges. In Q3, domestic passenger unit revenue fell by only 3%, while the transatlantic, transpacific, and Latin America regions posted 9.5%, 9.3%, and 5.3% declines, respectively.
Meanwhile, adjusted nonfuel unit costs rose just 0.9% year over year in Q3, indicating solid cost control. Finally, Delta's average economic fuel cost per gallon plummeted to $1.80 from $2.90 in the year-ago period. It was this huge fuel tailwind that catalyzed Delta's record profit.
The unit revenue trajectory slowly turns
Delta's Q3 passenger unit revenue decline of 4.9% was only slightly worse than the 4.6% drop it reported for Q2. The company expects the trajectory to improve next quarter, with passenger unit revenue declining 2.5%-4.5%.
Delta has worked hard to stem the tide of unit revenue declines -- it will hold capacity flat year over year in Q4 to bolster fare levels. Still, investors were probably hoping for better passenger unit revenue guidance after Delta previously predicted that it would get its unit revenue performance back to the flat line by year-end.
The Q3 press release made no mention of the flat unit revenue target, so it will be interesting to see what Delta's management says about that goal during the earnings call this morning. It seems likely that the timeframe has been pushed back, most likely to the first half of 2016.
Another stellar profit coming up
Despite predicting another passenger unit revenue decline for Q4, Delta expects to post strong earnings growth again, driven by fuel cost savings. Delta expects its operating margin to reach 16%-18% this quarter, compared to 12.6% in Q4 2014.
That's a great result for a seasonally weaker quarter. It also suggests that Delta's Q4 EPS will be better than the $1.16 that analysts had been expecting -- and could even exceed the most bullish analyst estimate of $1.26.
In premarket trading, Delta stock rose a little less than 2%, as investors tried to balance Delta's strong profitability against its unit revenue declines. However, with Delta stock trading for just 10 times the company's implied 2015 earnings, the upside seems much greater than the downside risk.
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.