Delta Airlines: All Ready for Take-off

Jacob 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 is known for being notoriously difficult, with issues ranging from costs to the capital intensity. Since 9/11, the industry has witnessed tremendous changes surrounding security, regulations, and operational costs. Overall, these variables have had far-bearing, negative impacts on the industry as a whole. But despite the difficulties, one airline in particular has an intense focus on reducing debt and controlling costs.

Delta Air Lines (NYSE: DAL) is one of the biggest airlines in USA.  Though the airline failed to impress with its latest earnings, which were below expectations, due to the impact of the last hurricane, which affected October revenue by $45 million and profitability by $20 million, still the company is advancing well on developing its supplemental revenue by adding new components to its services and enhancing the satisfaction and experience of passengers.

Efforts

The company is looking forward to investing more than $2 billion in 2013 to improve products, services, and airport facilities in the air and on the ground. Delta is making some relevant cuts in capacity in key international entities, which is expected to help the carrier amplify revenue beginning in 2013. The company is also planning to trim its structural cost by $1 billion, by retiring over 300 RJs by 2015, and back-filling with M90s, 717s, and 737-900s.

The debt part of the Balance sheet also seems to be improving, since the Airline major has paid down $5 billion in Debt since the end of 2009. For the third Quarter, the company paid down $270 million in debt, bringing adjusted net debt down to $11.9 billion and plans to reduce it to $10 billion by next year.

In June of this year, Delta ended up buying the Trainer refinery for $180 million, which management claims will reduce the fuel expense of the company by $300 million annually. CFO Paul Jacobson said that the refinery will post a small loss in the September quarter, but will begin to reduce Delta's fuel expenses in the December quarter.

Providing stability and certainty, company has signed a new pilot contract that lasts through 2015. The contract allows Delta to modify its regional fleet, replacing more than 200 50-seat aircraft with Boeing 717's that will be leased from Southwest. Delta is expected to save hundreds of millions in maintenance costs. Delta's pilots are also entitled to a 13% increase in pay slated for 2013, and 3% increases for both 2014 and 2015. Overall, the new contract provides a stable and a happier work environment, a pre-requisite for more productive pilots, and more productive pilots will lead to higher profits for Delta.

Delta entered into a number of deals with China Eastern Airlline Corp. (NYSE: CEA). Its agreement with China Southern (NYSE: ZNH) is paying off. The company, when compared to its competitors, is in a better position to reach out to global customers and to offer them the services because of the alliance with many of the international airlines.

The company in alliance with Alaska Air Group (NYSE: ALK) has initiated to increase international service and customer enhancement in Seattle, West Coast.  This step of Delta will take it closer to serve the major markets in Asia and provide better services to the passengers in the Pacific Northwest circuit. Delta also targets to improve services at Charles De Gaulle Airport in Paris in the middle of 2013, by bringing in more flights from 11 destinations in the United States.

Also, its merger with Northwest in 2008 is paying off now. Delta has made some nice gains in market share for the past 5 years in Atlanta, Detroit, Los Angeles, JFK, and LGA.

Delta is also in talks to buy Singapore Airlines’ 49% stake in Virgin Atlantic Airways. According to a report, Singapore Airlines could sell off its 49 % stake in Richard Branson’s venture to Delta which is supposed to be bidding for majority stakes. With the acquisition, Delta could gain access to Europe’s busiest airport and enhance its ability to garner lucrative Trans-Atlantic business traffic.

Market share & Competitors

Delta continues to dominate the market with 70 percent or greater share in its entire major hub. The Airline has also enhanced the market share where it has made recent investments. There have been small share losses in two of its major hubs- Memphis and Cincinnati - where the airline major’s share has declined to 56 percent and 71 percent respectively compared to 5 years ago.

In the recent quarter, airlines such as Deutsche Lufthansa AG (ETR:LHA) (PINK:DLAKY) (FRA:LHA) and United Continental Holdings have earned higher revenues compared to Delta airlines. Deutsche revenue totaled to $36.21 billion and United Continental net revenue was $37.38 billion.

However, on a positive side, as per a report from Raymond James, Delta earnings are least affected by the large pilot wage increase, also increments in the wages of non-contractual employees. Labor cost is the second largest expense item for airlines and on average accounts for 22% of U.S. carrier total expenses.

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Risk factors

Despite, strong global presence and stable earnings, Delta has some major issues. Although, the Airline major has paid $5 billion towards its debt and plans to pull down it down further to $10 billion in the books, the carrier remains highly levered given $12.1 billion in current adjusted debts, $11 billion in pension obligations, and future capital expenditure commitments.

The company suffers from a weak liquidity position. Currently the liquidity position of Delta is 10 percent of its sales, which can be considered as adequate, but when compared to the overall industry, falls on the weaker side. The dilemma over the hedges of the company being In-the-Money or Out-of-Money effects the cash position of the company if fuel prices hike.

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Delta’s acquisition of Trainer refinery, which management claims will reduce the fuel expense of the company by $300 million annually, may backfire. Historically, the refining industry has been one of the few manufacturing businesses where management has a negligible hold on margins. The oil refinery business is also a capital intensive business. Thus the stepping down of the carrier into oil refinery could impact earnings.

Opinion

Delta Airlines has transgressed far and wide in the past decade, from filing a Chapter 11 bankruptcy in 2005, to becoming a company on the radar of many analysts and consumers. The airline industry of today is nothing like it was a decade ago, but Delta has adapted to the volatile jet fuel prices by taking aggressive actions to decrease excess capacity, and even buying its own oil refinery. Delta Airlines is making great progress in trying to differentiate itself from its competition, by focusing extensively on the customer experience and not just on price. The company's efforts on reducing its costs and debt are already paying off. If the external factors like fuel prices, etc., behave as expected, we can witness a definite rally in the shares of Delta Airlines.

 

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Jacob Wolinsky has a short position in Delta, Aman Jain has no position in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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