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Delta Air Lines, Inc. (DAL) – Still Flying High

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The US domestic airline industry has been struggling in the past six or seven years. Apart from a few major airlines, many have been struggling to report profitability. The overall industry has witnessed a significant slowdown, since the financial crises of 2007/08. Delta Air Lines, Inc. (NYSE:DAL) is one of the few that has taken huge initiatives to reduce its cost in order to increase its operating margin. We believe going forward the Delta’s stock should be followed closely by the investors, as it seems set for an upward rally.

Delta Air Lines, Inc. (NYSE:DAL)Valuation Summary

1). According to analysis by Trefis, Delta Air Lines, Inc. (NYSE:DAL) Cargo SBU contributes 40% towards overall revenues

2). Delta US contributes 27% towards overall revenues

3). Delta International contributes 17% towards overall revenues

Recent history of the US domestic airline industry

US domestic airlines have witnessed an average YOY growth of 31.8% in operating profit since 2006.  The operating profits of US airlines took a major hit in the year 2008, when crude oil prices went as high as $147/ bbl. The industry suffered heavily, and to counter the high oil prices, airlines increased fares which led to a dip in demand and an overall loss of $3.7 billion to the US domestic airline industry. The hike in airfares to counter rising oil prices impacted the profitability and brought down the total unit sales for the industry by nearly 10%. The industry has witnessed an overall Compound Annual Growth Rate, or CAGR, of 14.32% in operating profit since 2006, and the last four years have not seen any increasing trend in this growth rate. I expect a robust growth of 50% in 2012 from the previous year, as the first two quarters of 2012 reported a collective operating income of $4.1 billion from domestic operations already. Going by the trend in the last two years, the industry has documented an average growth of 36% collectively in the final two quarters from the first two; I expect the 2012 operating profit from domestic operations of the US airline industry to reach $9.6 billion.

Airline industry striving to bounce back

The leading US airlines are making an effort to achieve historical productivity levels, focusing primarily on solving the labor issues that will eventually lead to aligning work rules and enhancing efficiency levels of the workforce on the front end. Additionally, new investments in technology innovation could present a realistic opportunity for airlines to increase efficiencies in the crew systems.  Thus, I estimate robust operating margins as the average domestic fares grow; however, oil prices are expected to remain within the current range of $80/barrel to $120/barrel, resulting in higher operating profit margins.

Delta cost cutting initiative

Several airlines are using archaic and less-fuel efficient planes, which can be damaging in a fuel-costly environment. Therefore, airlines are also focusing on fleet rightsizing. Although initially an extremely costly investment, the new aircraft will generate higher fuel efficiency than old outdated ones as well as reducing operating and maintenance costs.

According to Nasdaq, the airline is cutting down on the number of 50-seat regional jets, or RJs, in its domestic fleet and using instead two-class RJs and narrow body jets like the Boeing 737 that have largely lower operating and maintenance costs relative to 50-seat RJs. Delta is aiming to decrease the number of 50-seat RJs in its fleet to 125 by the year 2015 from 474 in 2009. The impact of this investment will set in over the next three years, as maintenance costs are likely to go down by $400 million per year. In addition, Delta is also striving hard to cut down distribution costs by increasing the share of to its total bookings, streamlining agent commissions and slashing merchant fees significantly. This will enable the carrier to keep its competitive edge over direct competition, and hence continue at the current growth rate.

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