Zacks_Analysts' Blog : Earnings Preview: Delta Air Lines - Analyst Blog

Delta Air Lines Inc. (DAL), the second largest U.S. airline, is slated to release its fourth quarter and fiscal 2011 earnings on January 25. The current Zacks Consensus Estimate is pegged at 37 cents for the fourth quarter, representing a massive year-over-year increase of 96.05% while for fiscal 2011, it stands at $1.33, representing a substantial decrease of 22.17% from the prior year.

With respect to surprises, Delta posted a 0.76% average negative earnings surprise over the trailing four quarters. However, in the third quarter, Delta posted earnings in line with our expectations.

Guidance

Last month, at its investor meet in New York, Delta Air Lines announced that it would earn a profit of $800 million for fiscal 2011 amid rising fuel prices and a slow moving economy. The company had already generated a profit of $429 million in the first nine months.

Excluding special items, Delta expects to generate adjusted earnings of $1.1 billion for fiscal 2011. Fuel expenses are expected to increase 30% year over year, resulting in $3 billion of additional fuel cost.

For the fourth quarter of 2011, operating margin is expected to grow as much as 8%, up from the previous projection of 5–7%. Delta expects to trim its consolidated capacity by 4–5% in the fourth quarter, with 3-4% in domestic flights and 4-5% internationally.

Third Quarter Flashback

Though Delta’s third quarter adjusted earnings were at par with the Zacks Consensus Estimate, earnings on a GAAP basis climbed year over year on the back of aggressive fare hike actions, cost-cutting measures and unbundled offerings.

The company reported improved revenue owing to higher passenger revenue per available seat mile, and surpassed the Zacks Consensus Estimate. Airlines traffic was stable from the year-ago quarter with slight decline in capacity (or, available seat miles) and small increase in load factor (percentage of seats filled with passengers).

Operating expense rose mainly due to higher fuel expense, currency translation, and capacity and revenue-related expenses.

Agreement of Analysts

Estimates reflect a positive bias for both the fourth quarter and fiscal 2011 over the last 30 days. 2 out of 12 analysts and 2 out of 11 analysts made positive revisions for the fourth quarter and fiscal 2011, respectively. One analyst moved in the opposite direction for both the period.

The analysts remained impressed with Delta’s initiatives to lower its overall cost including fuel price. The company has achieved success in passing the increased fuel cost to customers in the form of fare hikes and is also cutting capacity. Delta increased its ticket prices nine times successfully over 2011.

Delta is also slashing its non-fuel cost in a number of ways and expects it to be modestly up on a year-over-year basis in 2011. The company is dispensing with 70 less fuel-efficient planes from its fleet by the end of 2011 and the other 70 planes by the end of this year.

Instead, Delta will add 100 fuel-efficient Boeing Co. (BA) 737-900 ER jets by the end of 2012 and continue through 2018. This will lower the maintenance cost by $600–$750 million, including $250 million by the end of 2011.

The company is also resizing its workforce through 2,000 voluntary staff retrenchments and is consolidating facilities in Atlanta, Minneapolis, Memphis and Cincinnati. These initiatives are expected to save more than $80 million annually.

Moreover, on the revenue front, Delta is progressing well on improving ancillary revenues by adding new features to its services as well as expanding new products to improve passenger satisfaction and experience. Besides expanding the seating facilities of its fleet, Delta is also installing winglets and WiFi connectivity. Delta is moving ahead with the introduction of full flatbed seats in BusinessElite, expansion of the First Class cabin to more fleets and increasing Economy Comfort or Economy Plus seatsin their fleet.

Additionally, Delta Air Lines is going wireless with in-flight entertainment system called “Delta Connect”. These efforts to upgrade fleet products and services are expected to generate $150–$200 million in additional revenue in 2011 and a total of $1 billion by 2013.

Hence, the analysts believe incremental revenues and reduced costs will drive Delta profitability in fiscal 2011 despite the fact that fuel prices remain at high levels.

Magnitude — Consensus Estimate Trend

The Zacks Consensus Estimate for the fourth quarter fell by a penny over the last 7 days but grew by a couple of cents over the last 30 days to 37 cents.

The Zacks Consensus Estimate for 2011 remained static at $1.33 over the last 7 days and was up by 2 cents over the last 30 days.

Our Recommendation

Notwithstanding higher fuel prices and the threat of a recession looming large over Europe, 2011 and 2012 will likely mark the respective second and third consecutive year of profitability for the company. We expect Delta Air Lines to be profitable on the back of fare hikes, capacity reductions, new and improved ancillary revenues, expansion into new and untapped markets as well as hedging strategies.

Nevertheless, we remain on the sidelines due to steeply rising fuel prices,highly leveraged balance sheet, competitive threats from major rivals like United Continental Holdings Inc. (UAL) and Southwest Airlines Co. (LUV), unionized workforce and heavy investments, which might weigh on the bottom line.

We are currently maintaining our long-term Neutral recommendation on the stock. For the short term, the stock retains a Zacks #3 (Hold) Rank.