Delta narrows losses by more than half, expects 2Q2010 profits
As expected, Delta reflected the continued optimism felt in the industry since the fourth quarter, reporting stronger revenue during 1Q2010 when it posted a USD256 million net loss or USD0.31 per share. The results significantly narrowed its losses from the USD794 million, or USD0.96 a share, a year earlier. The big news is that it expects to be strongly profitable in the second quarter, despite the trans-Atlantic volcanic disruption.
Delta has already begun the volcano recovery process and expected to operate 50% of westbound flights yesterday and 100% of eastbound, said President Ed Bastion, who said the crisis forced the cancellation of 400 flights and cost USD20 million through Monday night at net USD5 million a day. It is also putting in extra sections where possible to work through the backlog of delayed passengers faster. It has been operating extra flights out of southern Europe – Spain, Greece and Italy– by adding extra sections, but is anticipating that it will be in full recovery mode for the next three to five days. Heathrow and Frankfurt remain the two most challenging airspaces.
Delta operating margin vs net margin: 2Q2008 to 1Q2010*
However, it would not project to the end of the year, citing fuel volatility, although it did not see a double dip to the recession.
“We are a bit optimistic as we head into the Summer travel season,” said Chair and CEO Richard Anderson. “Our loads are strong and building. Our yields are improving across all regions and business travelers are clearly back on the road. We are keeping a cautious eye on rising fuel prices, but remain committed to strategic priorities – delivering on our promised merger synergies, capacity discipline, investing in our product and maintaining cost discipline to deliver on the balance sheet.”
It has cut a deal with WestJet for codesharing, although no formal announcement has been made. Clearly the deal is better for WestJet than what it could have obtained from Southwest.
“That will give us feed within Canada and is important for our new alliance partners in China in terms of their Vancouver routes,” said Anderson, who discussed its recent deals for China Eastern to join China Southern as part of SkyTeam. “That gives us the ability to grow in the most important region in world, as well as the leading position in China. Our recent codeshare agreement with Gol complements our expansion into Brazil and gives us easier access to Uruguay and Paraguay.” He also noted Vietnam Airlines was joining SkyTeam.
No concerns about mergers, more worried about fuel
Anderson said there is nothing about the proposed mergers between United and US Airways or Continental that concern management. Even so, a merger would result in increased competition, but could afford some short-term opportunities as the resulting carrier rationalises routes, according to JP Morgan Chase’s Jamie Baker.
“I think our biggest concern in terms of the outlook is fuel,” said Anderson. “It is clear now the economy has pretty good strength. We feel pretty comfortable on revenue and demand despite the remaining issues with unemployment and commercial real estate. So we think the economy has pretty good legs now.” Fuel hit an 18-month high in early April.
Anderson noted that the difficulty it has had getting the Delta-US Airways slot deal past regulators reflected a less favorable environment in Washington. He also said that it would be hard to suggest mergers would be anticompetitive.
“Our [merger] was probably the quickest of its size that has ever gone through,” said Anderson. “I don’t think this environment is the same. The slot swap has actually been pending longer than the Delta-Northwest merger but that is because we had 270 lawyers between Northwest and Delta working on it and complied with the second document request within 90 days. We were ready. We produced 35 million documents and had some good economists who were doing econometric analysis from the beginning. The Justice Department was more inclined to base its decision on econometric evidence which found it was pro-competitive.”
"It's the court's call"
Senior Vice President and General Counsel Ben Hirst noted the legal standard remains the same regardless of administration. Then he said something very interesting. “Ultimately it is not the Justice Department that makes the call,” he said. “It is the court’s call. After the DOJ makes its ruling the parties are free to pursue the merger unless DOJ intervenes and the court agrees with it that the merger would be anti-competitive. That is a pretty hard thing to prove in this environment given the low-cost carriers and the fact that when you combine end-to-end networks you generate substantial consumer benefits. At the end of the day it will be the courts that decide.”
The question then becomes whether the Justice Department would find market concentration with a three-way deal between United, US Airways and Continental. Such a deal would dramatically change the US airline industry for the better.
One analyst asked which merger Anderson might favour and without missing a beat, he responded by saying he was not going to take that bait.
Noting that Continental stated its desire to remain independent unless the market changes, one analyst tried to ascertain whether or not Delta saw such a shift, especially with respect to corporate travel.
“On the revenue front, corporate travel is up 50% on a year-on-year basis,” said Bastion. “Clearly we are having significant wins and over the course of the last year we have picked up USD100 million in new corporate revenue share. Where that is coming from I can’t tell you, but we see the effects of that continuing. That is indicative of what we will be realising on the revenue front in the next year. In fact, for the first time in last several weeks revenue has been outpacing volumes meaning we have traction on net pricing. Corporate travel demand has improved in all geographic regions. It is strong in New York and the Trans-Atlantic and we see good performance at most of our hubs. Across the second quarter, one of the benchmark changes that will make comparables easier is the fact that H1N1 didn’t start until the end of April so we are already ahead.”
Anderson added that the company tracks corporate sold revenue and passengers week to week, year on year. “In our last snapshot, total corporate revenues were up 61% and tickets were up 46%", he said. “If you look at the trend line over the last year you see a steady upward slope to the right. Compared to two years ago it is up in dollars. We are not quite at 2008 levels but we are close to 2007 levels and expect to hit 2008 levels by year end.”
Comparisons to 2008 (year-on-two) are quite revealing. Consolidated operating revenues have fallen 15.4%, while operating costs have fallen 19.2%
Delta Air Lines 1Q2008 total consolidated revenue and cost vs 1Q2010 total consolidated revenue and cost
This has produced a turnaround at the operating level.
Delta Air Lines 1Q2008 operating profit/loss vs 1Q2010 operating profit/loss
RASM has fallen 18.2% over the two year period, CASM is down 21.9% and yield has fallen 17.1%.
Delta Air Lines 1Q2008 RASM, CASM and yield vs 1Q2010 RASM, CASM and yield
US Airways slot swap
While noting the conditions and terms of the slot swap agreement with US Airways have not been disclosed, Hirst said both sides remained fully committed to seeing it through to conclusion. “We think, first of all the FAA will act on the application before any merger related decisions could be made,” said Hirst. “We don’t see any reason for delay. The matter is ripe for decision. If there were to be merger agreement involving US Airways there is no reason for the slot-swap transaction not to go forward. Any kind of excessive concentration [resulting from a merger] would be for the Justice Department and the courts to decide on divestiture to deal with competitive issues. But we see it as independent of merger discussions under way.”
That was not good enough for JP Morgan analyst Jamie Baker, who concluded by saying he would continue to dig on that. The problem with the deal is it gives US Airways additional market power at Washington National Airport while United dominates Washington Dulles. If United and US Airways hope to gain regulatory approval, they will have to address their market domination in Washington DC. This would mean that the slots picked up by US Airways at National would be useless given the anticipated divestiture of assets the two would have to promulgate in Washington.
US Airways and United are not reporting their 1Q2010 results until next week, thus it will not be until then when the Phoenix-based carrier can weigh in on the viability of the slot-swap deal in the face of the Washington scene. United will likely be asked what it might do in Washington if such a merger is sealed but, on the whole, it is likely too early for a definitive answer from either.
Delta focused on reducing costs and debts
Anderson said the company has two main objectives this year. “We’ve got to maintain our cost discipline and we have to de-lever the balance sheet,” he said. “We are keeping our capacity in check flying the same amount as last year despite reducing the fleet by 71 aircraft. The results in the March quarter reflect our disciplined approach to costs. On a 4% reduction in capacity, our consolidated ex fuel unit costs is up only 1% year on year and for the full year we expect flat non-fuel CASM. We generated USD1 billion in operating cash flow in the quarter and ended March with USD5.6 billion in unrestricted liquidity while significantly reducing our net debt position. Now we’ve got to deliver merger synergies we promised and ultimately take that cash flow to strengthen the balance sheet and get this business model to work for all of our constituencies”.
Delta reported that a 2% total revenue growth resulted in 1Q2010 revenue of USD6.85 billion. Passenger revenue was actually up 4% to USD5.806 billion, despite a 4% drop in capacity.
Its passenger revenue per available seat mile (RASM) increased 8.4% to 10.89 cents, the first improvement since the end of 2008. That was despite a USD65 million revenue hit from this winter’s snowstorms which netted out to USD30 million. However, the airline did not discuss the total cost of those storms, leaving its estimate at lost revenues only.
It realised more than USD200 million in incremental synergy benefits from its merger with Northwest, with only USD36 million in merger-related costs. In addition, the capacity cuts are beginning to show yield improvements.
Regional revenue for the quarter grew 7% in the quarter to USD1.3 billion. Revenue was up 10.9% on a 3.6% decline in capacity while yield rose 5.6%. Contract carrier expenses grew 1% to USD917 million.
Pressure is continuing on the regional sector with 50 aircraft being spun out of the fleet this year and another 50 next year. This year it is shedding 35 50-seat CRJs and 15 Saab 340s. The aircraft retirements are part of an 85-aircraft reduction, including 36 mainline aircraft for Delta, but with deliveries this year the net reduction will be 71 aircraft.
“We are trying to make sure the regional business becomes more cost competitive,” said Anderson. “We are getting costs out just like at mainline. We have sufficient contract flexibility over next 18 months to right-size the 50 seaters, the least productive aircraft we fly so we will continue to reduce those shells.”
Operating expenses fell 5% to USD6.78 billion on an 11% drop in fuel costs coupled with merger synergies. Cost per available seat mile (CASM) ex special items and fuel fell to 8.72 cents despite a 4% decline in capacity. The carrier continued to rein in expense, dropping operating costs USD377 million in the quarter compared to 1Q-2009. Ex special items, operating expense decreased $340 million on lower fuel expense and merger benefits. However, costs savings were partially offset by higher revenue-related expenses.
Delta cost per ASM and revenue per ASM: 1Q2008 to 1Q2010*
At 31-Mar-2010, Delta's adjusted net debt was USD16.4 billion, a USD600 million reduction from the end of 2009. "Our strong operating cash flow this quarter allowed us to take important steps to strengthen our balance sheet by paying down USD375 million in debt, while also increasing our liquidity," said CFO Halter. "On the cost side, we successfully removed capacity-related costs from our system and remain on track to keep our non-fuel CASM flat for 2010 while still making important investments in our product and our people."
During the quarter, Delta and American Express amended their co-branded credit card agreement delaying repayment of USD1 billion in pre-purchased SkyMiles from Dec-2010 to repayment over a three-year period beginning in Dec-2010. These changes reduced Delta's 2010 and 2011 debt maturities by USD31 million and USD480 million, respectively. Its effect interest rate is 0%, making the move to stretch out payments to three years instead of two advantageous.
The company recorded USD46 million in merger-related expenses, USD10 million on Venezuelan currency devaluations and USD8 million in severance costs. In the year-ago period, special items accounted for USD99 million.
Bastion reported strong domestic advanced bookings which will result in double digit yield growth year-on-year in the second quarter. Advance yields are up more than 20% year on year, he reported, adding coach yields were higher as well.
The company projected its operating margin would be between 8% and 10% for the second quarter when it will conclude with USD6 billion in total liquidity. Its goal is sustainable operating margin in the 10-12% range. Its revenue guidance also projected double digit increases in revenue per available seat mile with 17% for April and improving on that in May and June.
Consolidated unit costs ex fuel will be flat to -2%, mirroring expectations for mainline unit costs ex fuel, mainline capacity, domestic and international capacity. Similarly, system capacity will be flat-1% which domestic flat and international flat-2%. Mainline is expected to be flat-2%
Consolidated unit costs ex fuel will be flat-2% mirroring expectations for mainline unit costs ex fuel, mainline capacity, domestic and international capacity. Similarly, system capacity will be flat-1% which domestic flat and international flat-2%. Mainline is expected to be flat-2% which was driven by a 5.1% increase in yield to 13.70 cents and a 2-point improvement in load factor to 79.5%.
Cargo dropped 5% to USD178 million on the cessation of its freighter operations, offset by higher belly-cargo yield. In addition, other net revenue dropped 4% to USD866 million on a decline in its maintenance, repair and overhaul volume and volume-related declines. However, baggage fees were up USD55 million year on year to USD215 million for the quarter. He said the company was expecting positive year on year growth in other net revenue and will finish the year with growth north of 10% of the USD3.5 billion in ancillary revenues it took in last year.
It ended the quarter with USD1 billion in operating cash flow and USD5.6 million in unrestricted liquidity, including USD4.9 billion in cash and USD690 million in undrawn revolving credit facilities. Its net loss, ex special items, of USD192 million was USD501 million better than the year-ago period ex special items.
It expects to complete its merger-related expenses at USD70 million by the end of the year, according to Bastion.
"We are encouraged by the improvements we continue to see in the revenue environment. We expect the positive revenue trends to continue and to be solidly profitable in the June quarter," said Anderson. "Delta's merger is quite successful and, through the hard work of the Delta people, we have now achieved USD1 billion in annual run-rate synergies."