Delta reports best operating margin in decade with half billion in profits

Merger gains

Well, they had predicted USD8.27 billion in revenues compared to the USD8.17 billion posted by the airline during the quarter and they are concerned about the recovery. The USD467 million net profit comes at a time, as CEO Richard Anderson pointed out, that is only in the early stages of global economic recovery and were better than the airline expected.

While double digit unit revenue growth will continue in the third quarter and the carrier projected solid profitability for 3Q2010 with a 10-12% operating margin, analysts expressed disappointment. "I would have liked to have seen more volume growth," Morningstar analyst Basili Alukos told Reuters. "It just shows you kind of a tepid recovery from the volume side."

While that is, indeed, something about which we should be concerned, especially given all the references to a double-dip recession in the last month, the theme set by Delta - capacity discipline, laser focus on costs, paying down debt and rising revenue that is expected to be repeated throughout this reporting season - didn't seem to provide any comfort. That continuing mantra, voiced over the last three quarterly reporting seasons, in an industry known for its lousy management, should be music to their ears. The language used by the Delta team and others continues to indicate that this time may, indeed, be so different as to signal that paradigm shift that observers have been waiting for - fiscally sound management in the industry, something we haven't seen since the industry's inception.

Anderson characterised the environment as "good, but not yet great", but compared to last year at this time, it could only be termed outstanding. Its operating margin reached 11.4% - the best in a decade - including a USD90 million investment in the employee profit sharing plan, said Anderson.

"Business is performing well and there is significant opportunity for improvement ahead," he told analysts during yesterday's call. "Operating revenues have increase 17% or USD1.2 billion while operating expenses have remained flat. Delta's profit this quarter is our best result in a decade and proof that our plan has positioned us well as the economy begins its recovery.

"We achieved USD 200 million in incremental merger synergies and anticipate finishing the end of the year with USD1.5 billion in synergies," he continued. "We will achieve our goals of USD2 billion in net synergies in 2011. The merger integration for all practical purposes is successfully complete."

Anderson went on to said the USD1.3 billion in free cash flow generated in the last two quarters will be used to continue to pay down debt. "We have reduced it by USD1.4 billion this year and are on track to get it down to USD10 billion in net debt in 2012. That is the most accretive method for creating value for our equity holders at Delta."

Yields up, especially Asia Pacific

Passenger revenue increased 19% or USD1.1 billion compared to the year-ago period on 1% lower capacity, while passenger unit revenue (PRASM) jumped 19.4%, driven by a 17% improvement in yield and a 1.9 point improvement in load factor. Cargo revenue was up 22% or USD38 million on both higher volume and yield. Other net revenue increase 3% or USD24 million mostly from baggage fees.

Unit revenues are still below 2008 levels, said Anderson, although domestic yield improvements is in the 15% range. Pacific is experiencing a strong recovery with advanced bookings well ahead of last year. Ticket yields are up significantly. Its trans-Atlantic alliance with Air France/KLM and Alitalia covers 26.3% of total transatlantic capacity with annual revenues of USD10 billion.

He also reported achieving USD200 million in incremental merger synergies for a year-end run rate of USD1.5 billion, on track for USD2 billion in 2011. He declared the merger integration successful. The company generated more than USD1 billion in operating cash flow driven by the company's profitability and advance ticket sales. Free cash flow was $778 million, while year to date, Delta has generated USD2.0 billion in operating cash flow and $1.4 billion in free cash flow.

Delta ended the June quarter with USD6 billion in unrestricted liquidity. Total debt payments in the June 2010 quarter were USD345 million, of which USD70 million was paid before scheduled maturity. At June 30, Delta's adjusted net debt was USD15.6 billion, an USD800 million reduction from 31-Mar-2010. During the quarter, the company prepaid its USD914 million revolving credit facility, which is now fully undrawn and available for future cash needs.

Ominous signs for regionals

The Delta Connection program operating revenues jumped 14% to USD1.5 billion while expenses rose only 1% to USD972 million, continuing a years-long profitability streak, even as the carrier sold off Compass and Mesaba during the second quarter. Contract carrier expense includes USD282 million and USD212 million for the three months ended June 30, 2010 and 2009, respectively, for aircraft fuel and related taxes.

In an ominous sign for regionals, Delta said the high RASM/CASM regional lift was being replaced by mainline aircraft. Still, said Bastion, the carrier would grow revenues efficiently with fewer airplanes, departures and lower unit costs. Maintaining capacity strength in the face of a recovering economy is at the core of our strategy to improve overall financial results," he said.

At the end of this year, Delta will have 91 fewer aircraft, but will generate the same revenue which equates to about a 1-point margin benefit. That will continue in 2011 as the fleet is further reduced by 20 aircraft. The company said that while that puts pressure on unit revenues, that would be more than offset by the benefit of lower unit costs.

Net income for the first half reached USD211 million, a USD1.2 billion swing from the year-ago period. Year to date operating revenue reached USD15 billion, up 10%, including USD2.8 billion for the Delta Connection program which was up 11%. Total operating expenses were flat at USD14.0 billion, including a 1% increase in Delta Connection operating expenses to nearly USD1.9 billion.

Delta financial highlights: 2Q2010

		2Q10 versus 2Q09
		Change	Unit
Passenger Revenue	2Q10 ($M)	YOY	Revenue	Yield	Capacity
Domestic	$ 3,152	15.7%	14.1%	14.2%	1.4%
Atlantic	1,358	19.4%	30.1%	25.1%	(8.2)%
Pacific	634	52.3%	36.2%	22.5%	11.8%
Latin America	336	16.9%	11.9%	10.4%	4.5%
Total mainline	5,480	20.0%	19.9%	17.3%	0.1%
Regional	1,529	14.2%	19.4%	16.7%	(4.4)%
Consolidated	$ 7,009	18.7%	19.4%	16.7%	(0.6)%

Source: company reports

Outlook: Flat capacity, higher yields

"We believe there's room for more revenue growth as the economy continues to stabilise," said Delta President Ed Bastian. "We anticipate double-digit year over year unit revenue gains for the September quarter."

On the cost side operating expense increased by only USD317 million, year on year, owing to higher fuel prices and profit sharing expense offset by merger synergies. Consolidated unit cost (CASM), excluding fuel expense, profit sharing and special items, was flat in the June 2010 quarter on a year-on-year basis, despite 1% lower capacity, although with those items it rose 5%.

"Delta exhibited strong cost performance this quarter as merger synergies and productivity offset cost pressures in the business. Synergies have exceeded our expectations and will be a key factor as we strive to keep our non-fuel unit costs flat for the full year," said Hank Halter, Delta's chief financial officer. "In addition, we continue to make excellent progress in delevering our balance sheet - generating nearly USD800 million in free cash flow this quarter and reducing adjusted net debt to USD15.6 billion."

Delta's Guidance

	3Q 2010 Forecast
Fuel price, including taxes and hedges	$ 2.33
Operating margin	10 - 12%
Capital expenditures	$ 250 million
Total liquidity at end of period	$ 6.3 billion
	3Q 2010 Forecast (compared to 3Q 2009)
Consolidated unit costs - excluding fuel expense and profit sharing	Flat
Mainline unit costs - excluding fuel expense and profit sharing	Up 0 - 2%
System capacity	Up 0 - 2%
Domestic	Up 0 - 2%
International	Up 2 - 4%
Mainline capacity	Up 1 - 3%
Domestic	Up 1 - 3%
International	Up 2 - 4%

Source: company reports

Delta Combined Statistical Summary (Unaudited): 2Q2010

	2Q2010	2Q2009	Change
Consolidated(1):
Revenue Passenger Miles (millions)	49,894	49,053	1.7%
Available Seat Miles (millions)	58,698	59,029	-0.6%
Passenger Mile Yield (cents)	14.05	12.04	16.7%
Passenger Revenue per Available Seat Mile (PRASM) (cents)	11.94	10.00	19.4%
Operating Cost Per Available Seat Mile (CASM) (cents)	12.18	11.55	5.4%
Passenger Load Factor	85.0%	83.1%	1.9 pts
Average Price Per Fuel Gallon, Net of Hedging Activity	$2.32	$2.06	12.6%

Source: company reports