Delta Air Lines Inc. (DAL), the second largest U.S. airline, reported a 2.2% year-over-year traffic increase in May fueled by both the domestic and international markets. Airline traffic is customarily measured in billions of revenue passenger miles.
On a year-over-year basis, consolidated capacity (or available seat miles) grew 2.2% while the load factor (percentage of seats filled by passengers) was flat at 83.9%. The increase in traffic was a function of higher demand despite headwinds like escalating fuel prices and a reduction in capacity.
Domestic traffic inched up 1.9% year over year on capacity growth of 0.4% and a 130 bps increase in load factor. International traffic rose 2.6% year over year on a 5% capacity increase partially offset by a 200 bps decline in load factor.
Delta Air Lines is cutting capacity to cope with persistently rising fuel prices and the changing dynamics of air travel demand. The company is passing the majority of fuel price increases to its customers in the form of fare hikes. In addition, the company plans to trim its capacity by 4% post-Labor Day in markets where strategies like fare hikes fail to adequately counter steeper fuel prices. Overall, Delta expects to cut 3% of domestic capacity, including a 25% reduction in departure at its Memphis hub with a 140 aircraft reduction.
In Atlanta, the company plans to slash capacity by 12%, in Latin America by 4% and in the Pacific by 3%. Further, with its trans-Atlantic joint venture partners –– Air France KLM and Alitalia –– capacity between Europe, the U.S. and Canada will be reduced by 7–9%. Delta Air Lines also plans to reduce maintenance and other non-fuel costs as well as accelerate retirement of less fuel-efficient planes.
Besides taking stringent steps as discussed above, Delta Air Lines continues to invest in the existing domestic mainline fleet by installing winglets to increase fuel efficiency and by expanding the First Class cabin to more fleets. In the international transoceanic aircraft, the company is installing full flat-bed seats in BusinessElite and adding in-seat audio and video in all cabins. Delta is further investing to add First Class to 70 and 76 seat regional jets in its regional aircraft.
The steeply rising fuel prices are expected to inflate Delta’s 2011 fuel expenses by $3 billion or 35% over the last year, thereby hurting its profitability. Although the aggressive fare hike actions and capacity cuts will help Delta to counter higher fuel costs, it might hurt revenue and profitability throughout 2011.
However, for 2012, earnings are expected to grow from the year-ago level aided by higher ancillary revenues such as expanded seat-related offerings and the launch of the international premium economy product – “Economy Comfort” – by the end of June as well as cost synergies from the integration of the Northwest merger. Ancillary revenues are estimated to reach $1 billion by 2013 while the merger will generate $2 billion in annual revenue and cost synergies by 2012.
We are currently maintaining our long-term Neutral recommendation on the stock. However, a highly unionized labor, a debt loaded balance sheet, competitive threats from large peers such as United Continental Holdings Inc. (UAL), AMR Corporation (AMR) and Southwest Airlines Co. (LUV), and the need to continuously invest in technology make us cautious on the stock. Thus, for the short term (1–3 months), Delta Air Lines retains a Sell rating with a Zacks # 4 Rank.
AMR CORP (AMR): Free Stock Analysis Report
DELTA AIR LINES (DAL): Free Stock Analysis Report
SOUTHWEST AIR (LUV): Free Stock Analysis Report
UNITED CONT HLD (UAL): Free Stock Analysis Report
Zacks Investment Research
