Delta JV may cut trans-Atlantic capacity 10%


It was pretty predictable. Over the past year or so, airlines have been pouring capacity into the trans-Atlantic market to the point that as early as last summer some were questioning just how long that would last given the across-the-board capacity increases. Indeed, during the first quarter earnings calls all the airlines noted the predictable decline in yields across the Atlantic announcing they would be imposing capacity cuts in autumn.

  • Delta and its joint venture partners are cutting capacity between 7-9% on trans-Atlantic routes due to declining yields and fuel costs.
  • The capacity cuts will be achieved through reduced frequency on select routes and right-sizing the trans-Atlantic fleet.
  • Delta plans to retire 140 aircraft this year, leading to slightly higher unit costs but offset by lower fuel prices.
  • Analysts predict a drop in operating margin for Delta due to the capacity cuts and increased fuel costs.
  • The Star Alliance is expected to be the next to cut capacity in response to economic and external cost pressures.
  • The Japanese earthquake disaster and political unrest in the Middle East have also impacted global airline capacity and profitability.

Now, Delta and its joint venture partners, Air France/KLM and Alitalia are the first to pull the trigger to quantify their cuts proving another benefit to their partnership - a coordinated response which is cutting capacity between 7-9% this autumn between the US/Canada and Europe. The cuts will come through declining frequency on select routes as well as right-sizing the trans-Atlantic fleet. At the same time, the four airlines plan to introduce seasonal sun destinations.

But Dahlman Rose Analyst Helane Becker reported Delta management is adjusting capacity in response to what it calls the new norm with fuel costs.

"DAL is reducing its trans-Atlantic capacity by 10%-12%, and its SkyTeam alliance partners are reducing capacity by 10%," she wrote in yesterday's research note predicting a drop in operating margin. "Delta is also reducing 2Q11 and 3Q11 capacity. DAL is planning to retire 140 aircraft this year, up from the initial plan to retire 97 aircraft. This will lead to slightly higher unit costs, but the lower fuel price forecast for 3Q11 should help offset some of the cost increase associated with lower capacity. We anticipate DAL will announce a narrowbody replacement order later in the year. There is no change to our hold rating."

Ms Becker estimates the Atlanta-based carrier's all-in fuel costs to be USD3.20, down from her previous USD3.26 estimate but still up 38% from a year ago.

"We estimate an operating margin of 8.8%, down from last year's 10.4%, and towards the high end of guidance of 7%-9%," she said, raising 3Q EPS estimates from 76 cents to USD1.13 reflecting higher revenues and lower fuel. "April unit revenue grew by 7%; May and June are estimated to grow by ~12%. Given that, 3Q is generally the strongest quarter of the year, we estimate unit revenue growth in the 10%-12% range, and double-digit operating margins. As a result, our diluted EPS estimate for DAL increases for 2011 from USD1.10 to USD1.45. And our diluted EPS estimate for DAL increases for 2012 from USD1.30 to USD1.48. 2Q11 EPS to partially benefit from lower fuel prices."

"Our alliance allows us to make strategic decisions about our network and operate as a single airline on trans-Atlantic flights," said Air France-KLM Executive Vice President Revenue Management and Network Bruno Matheu. "Combining our efforts, we are able to leverage the benefits of the joint venture to respond to economic and external cost pressures."

The question then remains who is next to cut capacity and it will probably be the Star Alliance. Interestingly, the capacity cuts come just as the American Airlines/BA/Iberia joint business is spooling up and includes a New York-London shuttle service. It is likely that some capacity will be cut with that joint venture as well but probably not as much as the other two alliances given the fact it has waited 14 years to even launch its joint business which happened only in the last several months.

The Pacific has been hit by the Japanese earthquake disaster and capacity there began coming out soon after the 11 March event. In addition, the domino-like revolutions in the Middle East has stemmed travel to the region, including the lucrative business trade.

While US airlines are still expected to be profitable this year - and who would have thought that even half a decade ago with fuel rising the way it is - the capacity cuts and global disruptions will definitely eat into their results.

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