'Heck of A Lot Better' Delta Predicts Big Profits
It wasn’t exactly an investor day event — Delta Air Lines will hold one of those in June, offering a deep dive on different areas of its business. Last week, in a meeting with investors, the airline’s chief focus was to share and explain its upbeat financial outlook for 2023 and beyond.
Delta now forecasts an 11 percent operating margin for the current October-to-December quarter, within a whisker of the 12 percent it earned in the same quarter of 2019. Recall that in mid-October, Delta expected to earn a fourth quarter an operating margin of 9-11 percent — that was before a significant decline in fuel costs. For all of next year, it expects the metric to be 10-12 percent (full-year 2019 operating margin was 14 percent). Operating margin is then forecast to rise 13-15 percent in 2024, which would restore profitability to its impressive pre-Covid trend. Impressive indeed: Among all airlines worldwide with intercontinental networks, none had higher 2019 operating margins than Delta.
How did Delta become so profitable? CEO Ed Bastian gave investors a bit of a history lesson, saying the airline did not have a sustainable business model prior to 2010, coming out of the global financial crisis and fresh from its merger with Northwest Airlines. In the first decade of the 2000s, Delta filled only about 70 percent of its seats on average. Last quarter, its load factor was 87 percent. Along the way, the company went from chronically-loss-making in the early 2000s to consistent double-digit profit margins throughout the second half of the 2010s. The reasons for the turnaround were many, but Bastian summed things up nicely: “The main thing we did was we utilized the assets a heck of a lot better.” Industry restructuring certainly helped as well: “We no longer have that overhang of seat capacity that continues to suppress the pricing in this industry.” Here’s all you need to know: From 1991 to 2019, Delta showed, U.S. airline domestic seat capacity increased 30 percent. Over that same period, domestic revenues rose 219 percent! If only airlines in other regions of the world were so lucky.
Post-pandemic, U.S. industry capacity and pricing trends stand to become even more benign. Another big merger is pending (JetBlue–Spirit). And supply-side constraints like pilot shortages, strained airport capacity, and reduced aircraft production will limit seat growth. Another deterrent to growth: airline industry costs are unequivocally ascending, the unpredictable vagaries of future fuel costs aside.
Higher non-fuel costs will certainly be a fact of life for Delta, made clear by its expensive new pilot contract (now awaiting ratification). Even after the airline restores normal productivity levels through greater utilization of existing assets, non-fuel costs are not going back to where they were pre-Covid. In 2023, Delta sees costs per available seat mile excluding fuel (CASM-ex) falling from this year’s levels but still lingering about 11 percent above 2019. Even in 2024, relative to 2019, CASM-ex will be up in the “high single digits.”
That can only mean one thing: Delta — to recapture its pre-Covid margin glory — will need its revenues to be up at least as sharply. Fortunately, white-hot demand since the spring has already lifted revenues above 2019 levels. Notwithstanding some negligible softness in December, demand continues to look great well into the first quarter of 2023. Delta, furthermore, sees more corporate travel returning as armies of consultants, attorneys, and accountants belatedly rediscover their normally hearty travel appetites. Executives furthermore point to the estimated $300 billion in “missing demand” lost during the pandemic but poised to return, and this time with people more mobile thanks to remote working. Next year, Delta expects revenues to be up 15-20 percent from 2022.
What if there’s a U.S. recession, as many economists predict? Bastian invokes the “this time is different” argument. “I don’t think that the pattern of 2019 for corporate travel is going to look like what we’re seeing into the future.” He cites the past approach of cutting corporate travel in bad times but “this is not a recession where you can do that. This is a recession [where] you have to grow your top line because they already have the cost out … that incremental reduction of travel spend is not going to matter relative to getting back out with your customers.” Delta President Glen Hauenstein added: “The differential between the … yield [for] leisure and business has converged over time. And so the trade-downs aren’t as pronounced as they were historically, which I think is a great shock absorber for us.”
Perhaps, though the U.S. hasn’t experienced a typical recession since 2009; the 2020 recession was deep but very brief, immediately addressed with massive fiscal and monetary support for households and businesses (which first was directed to goods spending and now is directed at services like leisure travel). The two consecutive quarters of economic contraction in the first half of 2022, meanwhile, was probably not a true recession at all given how robust the job market was. The point is, airlines really don’t know what a typical recession would do to their business. Are there really shock absorbers now? Would fuel prices fall in tandem, offsetting any demand weakness?
In any case, Delta isn’t relying on sustained strength in travel demand alone. On the contrary, management detailed a long list of internal actions and strategies designed to lift revenues. A few, in particular, stand out.
One is Delta’s valuable partnerships, which the company expects to yield even greater benefits going forward. These include its symbiotic relationship with American Express, currently delivering something like $7 billion in value to the airline. That’s billion with a “b.” Its overseas airline joint ventures, meanwhile, while disrupted by bankruptcies and other Covid-era misfortunes, are now bubbling with potential. No joint venture is more powerful and lucrative than the one Delta has with Air France-KLM, with Virgin Atlantic also in the mix. In Asia, Korean Air’s pending merger with Asiana greatly enhances Delta’s position in Seoul. “Once you put them together,” said Hauenstein, “they will have, by far, the largest hub in Asia and one that we can connect to and really funnel most of our Asia traffic — that we’re not going to serve nonstop — over their hub.” Cooperation with Latam is just getting started, having received antitrust immunity earlier this year. Like Latam and Virgin Atlantic, Aeromexico was pushed into bankruptcy by the pandemic, damaging Delta’s large equity holding. But it’s coming back strong, competing with just two other domestic airlines (both LCCs) in a country with 130 million people.
Delta also expects to produce higher margins in 2023 by growing in, well, higher-margin markets. Recently, it’s been allocating a large share of its growth to more competitive (read less profitable) coastal hubs, namely Boston, Los Angeles, New York, and Seattle. Now it plans to pivot and add seats to what you might call Bastian’s bastions, like Detroit, Minneapolis, and the Fort Knox of the airline industry: Atlanta. The bastion hubs were in fact losing some market share — even Atlanta losing some to Charlotte — as growth was directed elsewhere. Consider this year’s summer quarter, when scheduled seat capacity from Detroit, Minneapolis, and Atlanta were down 27, 22, and 16 percent, respectively, compared to three years ago, per Diio. Boston, by contrast, was up 17 percent, and New York’s LaGuardia and JFK combined down less than 10 percent. Note that some of the growth now directed to the bastion hubs involve the restoration of international capacity, including Asia flights from Detroit.
If Delta achieves its lofty profit goals, it will be in part thanks to a winning bet. Well before 2019, the airline placed its chips on premium traffic, allocating larger portions of its inflight real estate to products like Delta One (flat-bed seats), Premium Select (longhaul premium economy), and Comfort+ (extra legroom in economy). All have outperformed during the pandemic and continue to attract eager buyers. Speaking about Premium Select specifically, Hauenstein said “the returns on those? We’re getting fares that are generally double what we get for a regular coach product.” The push continues: As Delta receives new planes, they’re typically arriving with more premium seats than the planes they replace. Next year, it will offer roughly 15,000 more premium seats a day than it was in 2019. Before long, nearly one out of every three seats that Delta sells will be a premium seat. What’s more, Basic Economy seats — with no extra amenities — today account for a mere 5 percent of Delta’s seat bookings. In other words, even its economy class customers are willingly paying a premium, even if just to avoid being treated like a medieval serf when it comes to boarding priority, ticketing flexibility, seating preference, and loyalty plan benefits.
Bastian, Hauenstein, and Chief Financial Officer Dan Janki gave lots of other reasons for their optimism, ranging from fleet modernization to growth of non-ticket revenues. “We have a great story here to tell at Delta.”
A true story? Or a fairy tale? Stay tuned to find out.