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5 Things Delta Air Lines, Inc. Management Wants You to Know

By Adam Levine-Weinberg - Jan 25, 2016 at 2:30PM

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After a strong 2015, Delta expects another big improvement in performance next year.

Delta Air Lines (DAL -1.60%) reported yet another record quarterly profit last week, with adjusted earnings per share up more than 50% year over year. The strong performance was driven by a sharp drop in oil prices, partially offset by another quarter of big hedging losses.

Delta's earnings soared in 2015. 

Following the earnings report, Delta's management team spent an hour talking to analysts and the media about the company's 2015 results and 2016 outlook. Here are five things Delta executives emphasized in their remarks.

Performing above targets

We are on track to meet or exceed the targets ... of growing annual EPS greater than 15% and achieving returns on capital in excess of 20% and generating free cash flow in the range of $4 billion to $5 billion in 2016.
-- Delta Air Lines CEO Richard Anderson 

Last May, Delta increased its financial targets. Its new goals include producing a 14%-16% operating margin, 15% annual EPS growth, a 20%-25% return on invested capital (ROIC), $4 billion-$5 billion in annual free cash flow, and reaching net debt of $4 billion and an 80% funded pension plan by 2020.

In 2015, Delta exceeded its operating margin, EPS growth, and ROIC targets and made progress toward its 2020 debt target. Delta fell a little short of its free cash flow goal, though, due in large part to its significant hedging losses.

That won't be a problem in 2016. Delta has closed out all of its hedges for this year and expects to incur a comparatively modest $100 million-$200 million in quarterly hedging losses, while paying dramatically lower prices for fuel. This should allow it to produce free cash flow at or above the high end of its target range.

Demand remains strong

We're pretty optimistic relative to ... some of the pundits out there that are predicting the future. We are booked ahead in terms of load factor for each of the months: for February, March, April, and really out into early summer.
-- Delta Air Lines Chief Revenue Officer Glen Hauenstein

One of the biggest concerns among many airline investors is that demand might be softening. Delta and its legacy carrier peers all reported unit revenue declines in 2015, and recent stock market jitters have added new worries about a potential global economic slowdown.

Air travel demand remains solid, despite signs of an economic slowdown. 

However, Delta hasn't seen any evidence of a broad slowdown yet. In fact, advance bookings are up year over year for each of the next several months. Average fares are down a bit, but that's a natural result of lower fuel prices. Delta's fuel cost savings should far outweigh any fare weakness, leading to another year of margin expansion in 2016.

Pacific restructuring is working

In the Pacific, unit revenues declined 3%, a solid improvement from where we were trending earlier in the year helped by our significant network restructuring. Currency and fuel surcharges were a 13-point drag on unit revenue in the quarter.
-- Delta Air Lines President Ed Bastian

Delta executives have been talking about transpacific routes as a key profit improvement opportunity for a few years now. The urgency of Delta's restructuring project in the region increased as Asian currencies (particularly the yen) declined relative to the dollar.

To respond to these changing conditions, Delta is dramatically reducing its capacity in Japan, where it has traditionally operated a small hub in Tokyo. Instead, it is adding more direct flights to mainland Asia from its West Coast hubs in Seattle and Los Angeles.

Delta made a big round of cuts in Japan last fall, with total transpacific capacity down by 11.4% year over year in Q4, compared to 3.7% reductions in Q2 and Q3. That helped Delta limit its unit revenue decline in the Pacific region to 2.9% last quarter -- far better than the 9.3% drop logged in Q3. Delta expects to continue its progress in the region in 2016.

New tools boosting ancillary revenue

Sales of Comfort+ increased nearly 60% to $125 million in the quarter, and we see significant opportunity ahead now that we have started selling the product as a separate fare class.
-- Ed Bastian

Delta introduced an extra-legroom section called Economy Comfort -- more recently rebranded as "Comfort+" -- about four years ago. However, until recently, it was hard to book a ticket in this section. You had to buy a regular economy ticket first and then pay for the extra legroom as an upgrade later in the booking process.

Sales of Comfort+ extra-legroom seats are rising. Image source: Delta Air Lines.

Delta fixed this in November with a technology update that allows it to advertise a separate Comfort+ fare. This is already driving higher sales of Comfort+ seats. Customers can even book these seats on Expedia now, whereas previously, online travel agencies had always shown only the lowest fare for each airline. That should further bolster this revenue stream.

Share buybacks on the rise

And I would expect that ... given the performance that we're on pace to achieve that our share buyback number will be materially higher in 2016 than it was in 2015.
-- Richard Anderson

Delta spent about $2.2 billion on share buybacks in 2015, shrinking its share count by nearly 6%. The company has committed to spending at least that much on share repurchases again in 2016.

However, CEO Richard Anderson stated that Delta will likely increase its buybacks again this year. After all, the company expects to reap $3 billion in year-over-year fuel savings -- much of which will fall to the bottom line. Delta has already made substantial progress toward its 2020 debt target, and buying back more stock is a logical way to reward shareholders when times are good.

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.

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