Delta Air Lines (DAL), the second largest U.S. airline, has reported second quarter adjusted earnings per share of 43 cents, falling a penny short of the Zacks Consensus Estimate. Including special items, earnings per share plunged 58.2% to 23 cents from 55 cents in the year-ago quarter.
The shares of Delta Air Lines touched the 52-week low of $7.28 and closed at $7.61, down 41 cents from the previous close. The share price was the lowest amongst its largest rivals since November 2009. Aggressive fare hike actions as well as cost-cutting measures failed to counter the sharply rising fuel prices in the quarter.
Revenue
Revenue climbed 12% year over year to $9.15 billion and bettered the Zacks Consensus Estimate of $9.13 billion. Although the Japan disaster hurt total revenue by $125 million, improved performance in the reported quarter can be attributed to higher ticket prices, strong demand in Latin America and fuel surcharges.
Delta Air Lines was affected the most due to the natural calamity in Japan as it has the largest presence in the country relative to other U.S. carriers such as United Continental Holdings Inc. (UAL), AMR Corporation (AMR) and Southwest Airlines Co. (LUV). Notably, Delta generates almost $2 billion in revenue every year from planes flying the Tokyo hub.
Airlines traffic, measured in billions of revenue passenger miles, inched up 0.9% year over year. Capacity or available seat miles grew 2.5% and load factor (percentage of seats filled with passengers) fell 130 basis points year over year to 83.7%.
On an annualized basis, Passenger, Cargo and Other revenues increased 13%, 25% and 5%, respectively, in the reported quarter. Passenger revenue per available seat mile (PRASM) increased 9.9% year over year, led by a 14% PRASM jump in Latin America and a 12% domestic hike.
Operating Expenses
Total operating expenses increased 19% year over year in the second quarter. Fuel expenses, which were up 36%, drove more than 70% of the increase. Increased aircraft maintenance costs, and capacity and revenue related expenses also aided growth.
Consolidated unit cost or cost per available seat mile (CASM), excluding fuel and special items, increased 4.8% and CASM, including fuel and special items, grew 15.7% year over year in the reported quarter.
Liquidity
Delta Air Lines continues to enjoy a solid balance sheet. At the end of the second quarter, the company had $5.6 billion in unrestricted liquidity including $3.8 billion in cash and $1.8 billion in undrawn revolving credit facilities.
The company reduced its adjusted net debt to $13.8 billion from $14.5 billion at the end of fiscal 2010. Delta Air Lines is on track to reduce its net debt to $10 billion by 2013.
The company generated operating cash flow and free cash flow of $1 billion and $700 million, respectively, in the reported quarter. Capital expenditures were $300.
Guidance
For the third quarter, Delta Air Lines expects operating margin in the range of 7–9% and consolidated unit cost, excluding fuel, to grow 2–4% year over year. Fuel price, including taxes and hedges, is estimated at approximately $3.20 per gallon and total liquidity at $5.1 billion.
Further, the company plans to cut capacity by 4–5% in the fourth quarter in order to counter rising fuel prices. Delta Air Lines intends to trim domestic capacity by 1–3% and international capacity by 4-6%. In the trans-Atlantic route, the company with its partners, Air France KLM and Alitalia, will reduce capacity by 7–9%.
Our Analysis
We believe Delta Air Lines will generate solid profits going forward on reviving air travel demand, increasing fares, cutting capacity, new and improved ancillary revenues as well as hedging strategies. In addition, the company is trying to lower costs through job cuts and reduction in non-fuel expenses as well as by retiring 140 aircraft, which will generate $250 million in savings.
However, we are concerned about steeply rising fuel prices, unionized labor, the current debt loaded balance sheet and competitive threats from its large peers that are restraining the upside potential of the stock.
We are currently maintaining our long-term Neutral recommendation on the stock. For the short term, the stock retains a Zacks #3 (Hold) Rank.
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