Delta Air Lines: Best of the Bad
Tony is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
The airline industry has been a notoriously bad place for investors to put their money over the long term. That is because airlines historically move into the red if the global economy grows at less than a 2 percent rate and recessions do occur every several years. One of the reasons for the sector's poor long-term performance has been that airlines are subject to the whims of the oil market.
Consider the latest statement from the International Air Transport Association (IATA). It said that this year jet fuel will account for more than a third of costs at carriers around the world. It lowered its original 2012 forecast for profits for the industry to only $3 billion from $5 billion last September. IATA added that if geopolitical events push Brent crude oil prices above $115 a barrel for any length of time, the industry may face a loss of up to $5 billion. And that may occur despite demand for air travel exceeding capacity gains.
So if investors insist on putting money into the sector, how should they approach it? Should they go for a broad-based exchange traded fund like the Guggenheim Airline ETF (UNKNOWN: FAA.DL) or should they look at one of the fund's top four individual components – Delta Air Lines (NYSE: DAL), United Continental Holdings (NYSE: UAL), Southwest Airlines (NYSE: LUV) or US Airways Group (NYSE: LCC).
Probably the best bet is to try to find one of the major companies that will hopefully outperform its peers. Since jet fuel is such a key component to airlines' fortune, it makes sense to look to see if either Delta, United, Southwest or US Airways handle their fuel costs in a different manner than their competitors.
If one undertakes this exercise, Delta Air Lines immediately pops up. Its management must certainly be credited for thinking outside the box after, like its rivals, seeing its fuel costs rise about $3.5 billion between 2009 and 2011.
Only a few weeks ago, the company announced it will purchase an oil refinery in Pennsylvania for about $150 million. The facility can refine about 185,000 barrels of oil a day and after a $100 million upgrade, will produce roughly 52,000 barrels a day of jet fuel.
This is the first ever such move for a US airline and is expected to knock off about $300 million a year from its estimated $12 billion fuel expense, not to mention ensuring the availability of jet fuel for Delta. The refinery will provide about 80 percent of Delta's domestic jet fuel needs. Not bad for the money spent, about the equivalent of buying one widebody aircraft. The only possible concern here is whether Delta will hire experienced managers from the refinery business to actually run the refinery for them.
This purchase of a refinery is not the first time that Delta's management team has come up with an innovative approach when it comes to fuel costs. Just over a year ago, the company also had an industry first.
While its competitors were still living in the past, Delta Air Lines management realized that WTI crude oil futures were no longer the global benchmark and did not truly represent global oil prices. Prices on that contract have been held artificially low by the glut of US crude oil at the Cushing, Oklahoma, facility where many of the nation's oil pipelines converge.
The true global oil benchmark, reflecting global oil prices, is the Brent crude oil futures traded in London. Jet fuel prices are very closely aligned with Brent prices. So last year, Delta shifted nearly all of their oil hedges – to safeguard it against rising oil prices – to Brent futures and away from WTI futures. They did this while most of their rivals complacently continued to hedge via WTI futures, which gave them little protection against soaring jet fuel prices.
As one can see, Delta's management has some innovative strategies when it comes to one of their most important input costs. That should lead the company to outperforming its peers over the longer term and make their shareholders happy.
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