- Second quarter earnings season will be like nothing the airline industry has ever experienced before. And not in a good way. Delta gave the first indication of that last week, announcing a colossal $5.7b net loss, or $2.8b excluding special accounting items. Operating margin, if you really want to know, was negative 308% (seriously). The point is, Q2 was the first quarter entirely subsumed by the Covid crisis, for which revenue were minimal and capacity just a fraction of what it was pre-crisis. In the U.S., more so than elsewhere, airlines maintained at least some service from the very beginnings of the crisis in March.
In Delta’s case, Q2 capacity was about 15% of what it was in the same period a year ago. Revenues, meanwhile, were down 91%, totaling just $1.2b compared to $12.5b a year earlier. Like its peers, Delta worked furiously to remove costs, getting 45k workers to accept temporary unpaid leave. Others are working fewer hours. About 17k so far have voluntarily accepted permanent separation, induced by cash severances, health benefits, and travel privileges. More senior employees qualify for more generous benefits, and as senior employees leave, Delta’s average wages will helpfully fall.
Even so, matching a 91% drop in revenues with an equivalent drop in operating costs was never a realistic possibility. Not with much of an airline’s cost obligations fixed. Delta, furthermore, was unable to take full advantage of extraordinarily cheap $1.47 per gallon fuel. Instead, it paid $2.25 per gallon, even more than last year, because of bad hedges and, more importantly, $100m in losses at its Philadelphia oil refinery. All told, operating costs dropped only 53% y/y, impressive but not enough to offset the near-total collapse in revenues.
Bringing the airline back to profitability isn’t even on the radar right now. The priority is bandaging the bleeding, of cash most importantly, which burned at a rate of $43m a day last quarter. By June, the figure was $27m a day ($17m of that from domestic flying). It expects a similar number in July. And by the end of 2020, it hopes to get to cash break even. At current rates of cash burn though, Delta has some 19 months before liquidity would run short. And the real duration is surely much longer, given many additional cash-raising capabilities, including access to a $4.6b government loan program. At the end of Q2, liquidity stood at $16b, which is cash available for day-to-day survival if needed.
But hopefully, it won’t be needed, and eventually used instead to pay off all the new crisis-era debt. Indeed, Delta was eager to stress that its net debt (total debt minus cash) has only increased by $3.4b since the start of the crisis, far less than what it actually borrowed. Controlling net debt will of course be influenced by cash burn, and for burn to reach zero by the end of December, demand will have to regain at least some of the momentum it started losing a few weeks ago, amid the Sunbelt Covid spike, and as governments responded with quarantines and business re-closures.
Delta called demand growth “stalled at the moment” but emphasized the reduction in growth — bookings have flattened out but have not actually declined. In June, demand was growing at about 20% every week versus the prior week. That’s now down to more like 5% to 10%. But also important to note is the substantial amounts of additional capacity airlines have added for the summer, relative to the spring. About one-third of new revenue coming in, Delta says, is from customers using credits they took in lieu of refunds. The rest is from newly purchased tickets. As for Delta’s capacity, it’s pulling back some for August in response to the slower demand growth. Overall during the crisis, Delta claims to be “taking the industry’s most conservative approach to capacity.” Q3 seats will be just 20% to 25% of last year’s levels. Executives say the mid-summer demand slowdown is no surprise — they always expected things to be choppy.
They still expect to see a revival — sometime this fall — of the momentum seen in June. Said CEO Ed Bastian: “I don’t want anyone to get a sense that we’ve got a gloomy forecast on revenue or demand growth. Not at all. This is expected.” That said, Bastian thinks a full recovery will take about two years, and that corporate travel might never again reach the volumes seen in 2019. But it will ultimately strengthen and once again become important to companies, even in the age of videoconferencing.
Also key to Delta’s past and future success is international travel, which remains depressed due to closed borders and quarantine restrictions. For the moment, the carrier’s international partnership strategy is in tatters, bloodied by the deterioration of investments in Latam and Aeromexico, both bankrupt, and other troubled carriers including Air France/KLM, Korean Air, China Eastern, and Virgin Atlantic. Such partnerships though, remain a longterm strategic priority. Delta in fact is supporting Virgin Atlantic’s financial rescue by deferring collection of some brand and joint venture fees it typically charges (see feature story). With Latam, it’s proceeding with a joint venture covering North and South America. Delta’s most important partner isn’t even an airline.
It’s American Express, which says Delta-branded credit cards aren’t seeing quite as much spending decline as seen with its other cards. That’s a small plus for Delta. The strong cargo market is another. It’s a good time to accelerate airport projects in cities like New York, Los Angeles, and Salt Lake City. Old planes are headed for early retirement, including all B777s, B737-700s and MD-88s/90s. Some B767s-300ERs and A320s will leave as well. No longer will Delta buy A350s from Latam. It’s now talking to Airbus about cancelling and deferring deliveries. “Clearly, we’re in a situation where we don’t need any aircraft.” In all, Delta will permanently retire more than 100 planes this year, symbolic of an industry becoming a lot smaller.
That of course means many job losses after Oct. 1, when federal payroll support expires. Delta, like its peers, is trying to make as many of the job losses voluntary as possible — its workforce will soon be about 20% smaller. (See labor section). What will the next six months look like? How about 2021? Uncertainty levels are extremely high. When will borders reopen? Can the U.S. get some degree of control of the virus? Will Congress pass another economic stimulus package? How bad will the economy damaged in the long-run? Will there a be breakthroughs in Covid treatments? When will vaccines ultimately save the day? Delta, for its part, is going farther than most in trying to make travelers feel comfortable and secure. It’s still blocking middle seats, for example, and isn’t in any rush to end that policy. It’s also vigorously adhering to public health recommendations, i.e. enforcement of mask wearing. No less vigorous is Delta’s outspoken support for racial equality and social justice.
For Delta’s business to ultimately recover, it will need to make big changes and adjustments, even more so than rivals less wired to serve corporate, premium, and international demand. Delta was a champion of the world that vanished with Covid. Can it be a champion of the post-Covid world too?
Madhu Unnikrishnan
July 20th, 2020