As Delta results are announced, it is worth thinking about fuel prices

Dino D'Amore
By Dino D'Amore April 15, 2015 10:38

As Delta results are announced, it is worth thinking about fuel prices

As Delta impresses once again its figures for the quarter do show that it is being pressured hard on Pacific routes, especially Japanese routes. But if investors start thinking long term then Delta is very well placed for long term growth as its Atlanta hub is at the centre of a significant population movement in the USA toward the southern states. This may benefit Delta in shifting passengers internationally but it is the case that Allegiant and Spirit Airlines along with American are at the centre of a rapidly growing region that now boosts some 34% of the total USA population. Investors will be looking to ensure that Delta’s domestic route network is able to feed the international operation and draw people away from competitors.

The Delta refinery (Trainer) is adding to its profit figures in ever increasing amounts. Delta was wise to get out of its hedges early. Even though fuel prices are all over the place at this time one thing is for sure, Iran has the ability to throw very large amounts of oil onto the international market if sanctions are lifted. This will take much of the pricing power out of the hands of the Saudis. It is a far cry from the 1970s when Iran was pumping 6m barrels per day but recently Iran dramatically increased it production capacity to 3.1m barrels per day from 2.9m and the expectation is that if sanctions are fully lifted then Iran will move to attract back the Western producers (that will take some doing) to get oil production back above 5m barrels per day. If that were to happen, low oil prices would be here to stay for some time. In the here and now, Iran is already placing itself to shift some 30m barrels worth in floating storage towards the end of 2015. The key for Iran will be gas exports to Europe in the next decade if Iran continues on its course for a sanction free future. Iran has huge gas reserves and Europe is desperate to diversify from Russian dependence. All in all Iran could well see a massive economic boom over the coming decade and airlines should be ready to start serving the country as soon as its doors fully open.

Delta’s adjusted pre-tax income for the March 2015 quarter was $594 million, an increase of $150 million over the March 2014 quarter.  Delta’s adjusted net income for the March 2015 quarter was $372 million, or $0.45 per diluted share, and its adjusted operating margin was 8.8%. On a GAAP basis, Delta’s March quarter pre-tax income was $1.2 billion, operating margin was 14.9% and net income was $746 million, or $0.90 per share. The results for the period include $136 million in profit sharing expenses, while $500 million was returned to shareholders during the quarter through dividends and share repurchases and $904 million of pension contributions was paid.

“Delta’s business is performing well, producing the best March quarter, both operationally and financially, in Delta’s history,” said Richard Anderson, Delta’s chief executive officer.  “While the strong dollar is creating headwinds with international revenues, it also contributes to the lower fuel prices which will offset those headwinds with over $2 billion in fuel savings this year.  We are looking at June quarter operating margins of 16-18 percent with over $1.5 billion of free cash flow these record results and cash flows show that the strong dollar is a net positive for Delta.”

Delta plans to reduce its international capacity by 3% year over year for the winter schedule.  These international reductions, combined with 2% domestic growth, will result in flat system capacity for the December quarter ahead.  Capacity adjustments will be focused on markets that have been most affected by the strong dollar and markets where demand has been negatively impacted by the decline in oil prices.  Key actions for the December quarter will include a 15-20% reduction in service from Japan, a 15% reduction to Brazil, a 15-20% reduction to Africa, India and the Middle East, and suspension of services to Moscow for the winter season.

Delta’s operating revenue improved 5%, or $472 million, in the March 2015 quarter compared to the March 2014 quarter.  Traffic increased 3.6% on a 5.0% increase in capacity, which includes 2 points due to capacity removed in the first quarter of 2014 as a result of winter storms.  Foreign exchange pressured revenue by $105 million for the quarter.

All the while Passenger revenue increased 3%, or $246 million, compared to the 2014 March quarter.  Passenger unit revenue (PRASM) decreased 1.7% year on year driven by 1.5 points of negative foreign exchange impact. Cargo revenue was flat year on year as higher volumes offset lower yields. Other revenue increased 22%, or $226 million, driven by SkyMiles revenues and third-party refinery sales.

Delta states that the substantial benefit from lower fuel prices will again more than offset the unit revenue decline of 2 to 4% for the June quarter to produce operating margins north of 20% at market fuel prices. Adjusted fuel expenses increased $23 million for the quarter as lower market fuel prices were offset by $1.1 billion of settled hedge losses, including $300 million of early settlements of contracts originally settling in the second half of 2015 as the company restructured its hedge book.  Delta’s average fuel price was $2.93 per gallon for the March quarter.  Operations at the refinery produced an $86 million profit for the March quarter, a $127 million improvement year-over-year.

Consolidated unit cost adjusted for fuel expense, profit sharing and special items (CASM-Ex), was down 1.4% in the March 2015 quarter on a year-on-year basis, with higher capacity, foreign exchange and the benefits of Delta’s domestic refleeting and other cost initiatives offsetting the company’s investments in its employees, products and operations.

“With nearly 10 percent of our expenses non-dollar denominated, we are seeing cost tailwinds from the strong dollar which should benefit our non-fuel unit costs by 1 point in the June quarter,” said Paul Jacobson, Delta’s chief financial officer.  “With this currency benefit and the strong cost control that is a hallmark of the Delta culture, we are on track to deliver our eighth consecutive quarter of non-fuel unit cost growth below 2 percent in the June quarter.”

Adjusted for special items, non-fuel operating expense in the quarter increased $333 million year-over-year driven by wage increases, profit sharing, and higher volume-related expenses.  These cost increases were partially offset by foreign exchange and savings from Delta’s cost initiatives.  Non-operating expense, adjusted for special items, declined by $34 million as a result of $55 million in lower interest expense, partially offset by an $11 million higher foreign exchange loss on foreign-denominated assets and liabilities compared to the first quarter of 2014.

Cash from operations during the March 2015 quarter was $1.1 billion and free cash flow was $511 million, driven by the company’s March quarter profit and the normal seasonal increase in advance ticket sales.  Cash flow from operations and free cash flow exclude the return of fuel hedge margin posted.  Capital expenditures during the March 2015 quarter were $586 million, including $411 million in fleet investments. During the quarter, Delta’s net debt and capital lease maturities were $260 million.
Delta ended the quarter with adjusted net debt of $7.4 billion, including cash held by counterparties as hedge margin.  The company has achieved nearly $10 billion in net debt reduction since 2009, resulting in a roughly 50% reduction in annual interest expense.

For the next quarter, Delta expects its operating margin to be 16-18%, with its CASM up slightly and capacity up by 3%.

Dino D'Amore
By Dino D'Amore April 15, 2015 10:38