Any company that is experiencing rising costs needs to have an impressive strategy to overcome them. Delta Air Lines Inc.’s (DAL, Financial) fuel and non-fuel costs have continued to grow in recent quarters, causing its near-term financial outlook to come under pressure.
The company, though, seems to have put a solid growth strategy in place. Changes such as increased capacity on highly demanded routes, greater access to the lucrative corporate market and an expansion into Asia could act as catalysts on its future performance. A renewed focus on customer service and replacement jets may also help it to perform well in the long run.
Quarterly update
Recent second-quarter results from Delta were mixed. Revenue increased 9.6% from the prior-year quarter to $11.78 billion. Revenue per available seat mile increased 4.6%, which was down slightly from the 5% growth recorded in the first quarter of the year.
Rising fuel costs weighed on the company’s profitability. The price per gallon of jet fuel increased to $2.17 from $1.66 in the year-ago quarter. This increase in fuel costs was accompanied by a 2.9% rise in non-fuel costs. Together, they squeezed the company’s pretax margin so that it declined to 13.9%. It was 16.8% in the same period last year.Â
Growth potential
Since the release of its second-quarter results in July, Delta's stock price has risen 17%. This takes its gain over the last year to 25%, which is above the S&P 500’s rise of 18% over the same period.Â
Delta’s decision to increase capacity on its transatlantic routes could catalyze its financial performance. In the second quarter, the company’s unit revenues increased 11% on transatlantic routes. This continued a trend of increases over recent quarters. As a result, the airline is expanding the number of flights on routes such as Los Angeles to Amsterdam, among others, where it has a strategic advantage in terms of connecting its own hubs with those of its European partner, Air France-KLM (XPAR:AF, Financial). The addition of extra capacity on popular routes should lead to higher profitability in a short span of time.
The outlook for Delta’s corporate business seems to be strong. It has only been able to recover 20% of the decline in domestic corporate fares since its peak in 2014. This indicates there is a significant amount of business yet to be won over the medium term. The company’s close relationship with American Express (AXP, Financial) could help it to benefit from a competitive advantage among corporate customers. Similarly, its focus on expanding digital sales through the launch of new versions of its website and mobile app may help to increase customer satisfaction and booking numbers.
Improved strategy
Delta is focused on improving customer service levels, which could boost sales performance over the medium term. It plans to expand its Premium Select seating across all of its international widebody aircraft by 2021. This follows the successful launch of its long-haul fleet last year. The average fare premium versus a standard seat is over 100%, with Premium Select seating taking up less than twice the space of standard seating.
Growth potential in Asia may also be a catalyst for the company’s stock price. A recently launched joint venture with Korean Air (XKRX:003490, Financial) could help to facilitate growth in the region. The company is planning to expand its capacity to South Korea over the medium term. With strong unit revenue growth in South Korea last quarter, it could prove to be a key growth area for the business in the future.
Rising costs
Rising costs continue to be a threat to Delta’s profitability. A higher oil price meant adjusted fuel costs moved $578 million higher in the second quarter when compared to the year-ago quarter. Similarly, non-fuel costs have been rising rapidly. They increased 3.9% in the first quarter of the current year, with growth of 2.9% recorded in the second quarter. Rising costs could squeeze margins over the medium term.
In response to rising costs, the company is seeking to become increasingly efficient. It is in the process of delivering a major cost-cutting program, while also replacing a large part of its fleet. This is expected to lead to reduced fuel consumption due to more efficient planes replacing older models. Reduced maintenance costs for newer planes may also help to cut non-fuel costs. With new jets expected to replace a significant proportion of the company’s fleet, cost savings from the fleet-renewal program could be substantial over the next several years.
Verdict
Delta’s focus on expanding capacity on transatlantic routes could act as a catalyst on its financial performance. Alongside the potential for growth in corporate sales and expansion in Asia, this could have a positive impact on its stock price over the medium term. Although increasing costs may hold back its progress to some extent, the cost-reduction efforts being made could help to maintain margins and lead to profit growth. Therefore, after outperforming the S&P 500 over the last year, further stock price appreciation could be ahead for the company.
