Seeking Alpha

Despite Global Uncertainty, Delta And United Vie For Air Travel Leadership

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About: Delta Air Lines, Inc. (DAL), UAL, Includes: BA
by: Tim Dunn
Tim Dunn
Long/short equity, event-driven, airlines, foreign companies
Summary

U.S. global airlines have a dominant position of leadership and profitability.

The strong U.S. economy and globalization provide new opportunities to connect the U.S. travel market with the world.

Geopolitical and economic challenges around the world provide opportunities, particularly for Delta and United.

Network growth and fleet replacement will require hundreds of new international aircraft, of which Boeing itself has unique opportunities.

As 2020 begins, the big 3 U.S. airlines, American (NASDAQ:AAL) , Delta (NYSE:DAL) and United (NASDAQ:UAL), also known as the US3, are hopeful that the New Year will bring new global opportunities even as they build on a strong domestic air travel market. As I noted in this recent article on transatlantic opportunities, each of the big 3 are among the top 10 largest airlines in the world in terms of long-haul international capacity. U.S. airlines also contribute a disproportionately large amount of global airline profits. Based on currently published schedules for the summer of 2020 (which are subject to change), United will have the 2nd largest amount of longhaul international capacity in the world while Delta will be third in that ranking. UAE-based Emirates is the world’s largest longhaul international carrier.

Buoyed by a strong but mature domestic market, the US3 are taking advantage of their own strength relative to the global industry to grow in strategically important markets. Unlike their low cost carriers in the U.S., the US3 have invested billions of dollars in asset and route acquisitions, aircraft and infrastructure over decades in order to connect the U.S. to the world. The U.S. remains the world’s richest air travel market – buoyed both by a healthy demand for air travel by an increasingly diverse population of Americans traveling to the rest of the world as well as strong tourism and business opportunities in the U.S. for residents of many parts of the world. Changes in airline products and services as well as new aircraft technology amplifies the opportunity for U.S. airlines in an increasingly globalized air transportation system.

Recent global events highlight that airlines are never exempt from global uncertainties – and yet security enhancements and better cooperation between government and the airline industry worldwide have helped to keep U.S. airlines out of the geopolitical tensions of the world. Movements in the price of oil, which has long been a key factor in airline stock prices, are becoming less of an immediate threat to airline profitability as aircraft fuel efficiency grows and the U.S.’ relation to global oil markets changes.

Worldwide, there is in increasing recognition by governments that have long propped up money-losing airlines as tools of economic development that such actions are no longer sustainable. The U.S. airline industry is the most profitable in the world and U.S. airlines are increasingly able to compete with airlines from countries that have been slow in transitioning to a fully market-based approach to commercial aviation.

DAL Global ScaleDelta Global Scale source: Delta Investor Presentation, p 15

Global Opportunities

Here are just a few indicators of a changing global aviation marketplace which will benefit U.S. airlines, either as a result of actions American, Delta or United are taking or because of difficulties facing major foreign airlines throughout the world.

- As I noted in my previous Seeking Alpha article, more than a half dozen leisure oriented European airlines have ceased operations over the past 3 years as their business models are proven to not be viable.

- Norwegian, the largest transatlantic low cost airline, has shifted from a market share to a profit maximization strategy and is cutting dozens of flights, esp. during the off-peak winter season, allowing remaining capacity on other airlines to be priced more rationally.

- Attempts to find investors in Italy’s perennially loss-making Alitalia have stumbled even as the E.U. continues to pressure the Italian government to eliminate state support for Italy’s flagship airline.

- A firm date for Brexit comes as Delta has just implemented a four-way joint venture with Air France/KLM and Virgin Atlantic of the U.K.

- Airbus’ decision to cease production of the A380, the world’s largest passenger aircraft, will most impact the three largest Middle East airlines – Emirates, Etihad, and Qatar (ME3)– where the majority of the A380 fleet operates. While it will take years for the A380 to leave those fleets, the restructuring of the ME3’s networks to focus on more frequent flights on smaller aircraft will likely reduce the ability to offer large numbers of deeply discounted connecting fares; the US3 has charged that the large number of low fares offered by the Middle East carriers has pushed down the ability of the US3 to serve markets that are served via connections by the ME3. The ongoing economic blockade of Qatar and the fracture of the Arab Middle East has introduced inefficiencies that negatively impact the ME3’s financial results.

- The failure of Jet Airways of India led in part to Delta’s decision to restart service to India, this time with nonstop JFK-Mumbai flights. United has flown to both Mumbai and Delhi for years and has recently added winter seasonal San Francisco-Delhi flights. Other Indian airlines continue to struggle financially.

- China admits that its airlines have lost more than $3 billion flying international routes in just one year, a likely admission that it cannot sustain that level of subsidies for its airlines. Round-trip fares from the U.S. to China are as low as $300 which has negatively impacted U.S. airlines that have not been able to sell enough higher fare tickets.

- Political unrest in Hong Kong has weakened Cathay Pacific and diverted traffic and economic activity away from the former British colony. Delta ended service to Hong Kong in 2018 while United has reduced capacity and recently announced a second impairment charge for its Hong Kong assets. American says it will maintain its current levels of service as part of its long-term strategic plans.

- The planned signing of the first phase of a new trade accord between China and the U.S. removes at least some of the pressure that has depressed air traffic between the two countries.

- In March, Delta moves its flights from Beijing Capital airport to the new Beijing Daxing airport in March, providing the first service from the new airport and the United States and as part of the move of the majority of its partner, China Eastern’s, flights from Capital to Daxing. Creation of a dual international airport system for Beijing is intended to significantly boost capacity for Beijing including by reducing the number of flights at previously congested Beijing Capital airport where United and its partner Air China operate.

- Rekindled post-war tensions between S. Korea and Japan have cut economic activity between the two countries even as S. Korea’s Asiana has been sold in an effort to reverse years of losses, likely leading to service reductions.

- Also in March, Delta moves all of its Tokyo flights to close-in Haneda airport while United and American gain additional flights at Haneda and expand their overall Tokyo operations at both Tokyo airports ahead of the Olympics this summer.

- Latam, Latin America’s largest airline, sold a 20% interest to Delta in a move that will certainly lead to new routes and revenue growth via increased cooperation. United has been trying to enhance its own partnerships in Latin America and is certain to accelerate those efforts.

- Alaska, JetBlue and Southwest have all ended service to Mexico City after receiving slots at that airport as part of the approval of the Aeromexico-Delta joint venture.

Delta 767-400 over GreenlandDelta 767-400 overflying Greenland source: JetPhotos

Differing strategies between American, Delta, and United

While having just been overtaken by Delta as the world’s largest airline by revenue in 2019, American’s international strategies are developing considerably differently than Delta and United’s now six years after American’s merger with predominantly domestic USAirways. American cancelled several routes to Asia in 2019 and is operating a higher percentage of its total annual international capacity on a summer seasonal basis, leaving a much smaller year-round global network than Delta and United. DOT data also shows that American loses hundreds of millions of dollars per year flying Pacific routes and operates its transatlantic network at very low single digit margins on an annual basis. American is the largest carrier in Latin America and operates the only U.S. carrier hub at Miami to Latin America; the company says its Latin America operations are consistently and strongly profitable. As such, American is unlikely to grow significantly in the transatlantic and transpacific regions, which are the two largest global regions for U.S. airlines.

Delta has long been the most domestic-focused of the three U.S. megacarriers but now says it wants to grow its international system to eventually deliver 50% of its revenues – up from about 30% today. Delta’s most unique strategy is its equity investments in more than a half dozen partner airlines around the world; including Latam, its most recent investment, DAL’s foreign carrier equity portfolio now exceeds $4 billion. Delta has joint ventures with a number of carriers including some of its equity partners; Delta gains a presence on the board of directors of its equity airlines, providing a level of insight into the company that goes beyond even joint ventures. Delta’s international network has been heavily built around its partners, often providing the ability to connect passengers on both ends of its international routes as well as gain a stronger marketing presence via its partners. Delta has also used its strength in cities other than its U.S. hubs to connect medium-sized cities throughout the U.S. to its partners’ hubs, providing more U.S. longhaul international gateways than any other U.S. airline. Delta’s medium-term international growth will likely include Asia and with additions from its new hubs in Boston and Seattle as well as developments of its Latin America system. Delta’s African network garners above average fares and could see growth.

United had a significant head start over American and Delta in developing its international route system, buying Pan Am’s Pacific operation in the mid 1980’s and developing it into the world’s largest transpacific operation. United later bought Pan Am’s London Heathrow authorities and developed an extensive alliance with the Lufthansa group of airlines in Central Europe. When it merged with Continental, United gained a large multi-continent international operation from Newark and an extensive Latin America operation, primarily centered at Houston. United’s international network is built around the largest cities in the U.S. where it competes effectively with many of the world’s international airlines from its hubs; United has not connected small and medium-sized cities in the U.S. to its global network as well as American or Delta. United has aggressively added ultra long haul flights (over 16 hours) including with seasonal service to countries like S. Africa that it does not serve on a year-round basis. United’s advantage is the sheer size of its international network which effectively covers nearly all of the top U.S. and global markets. One of United’s strategic priorities will undoubtedly be to respond to Delta’s investment in Latam which boosts Delta’s position in a region where it was last among U.S. airlines, now leaving United potentially in that position.

Based on current trends, it appears that Delta and United are vying to be the U.S.’ two largest global airlines as well as to carry the premium revenues that are necessary to support the high costs associated with the diverse fleet involved to serve global markets.

United Polaris Cabin on the 777-300ERPolaris Cabin on a United 777-300ER, source: United Airlines

Service Philosophies

While there are many international passengers that vow that the US3 do not offer service competitive with foreign carriers, the US3 have been making extensive investments in their products and services, especially in the international arena. All of the US3 offer a lie-flat business class product with direct aisle access as their highest premium cabin offering, although not all aircraft for some airlines currently offer that service with United slow to roll out its new Polaris cabins. United configures its international aircraft with a larger number of premium cabin seats than American or Delta but the higher number of premium seats often means fewer seats overall on the aircraft, or a more dense configuration for other cabins.

American and United both operate large fleets of 777s and 787s and have chosen the more dense configuration that results in less seat width than the original cabin configuration for those two aircraft. Delta, positioning itself as a premium airline, is one of the few large airlines in the world that has retained wider seats on its 777s, providing one of the widest international economy seats of any aircraft. The standard seating configuration on Delta’s A330 and A350 provide greater seat width than the narrow configuration on the 777 and 787.

American, Delta and United have all rolled out premium economy cabins on their international fleets and indications from all three carriers are that demand for the product is very strong. The premium economy cabin features an even wider seat than in economy that offers greater recline and a footrest, enhanced food service and dinnerware, and other priority passenger benefits. All three airlines also offer a more legroom economy product which is the same seat as in standard economy with more space between rows and a slightly increased recline. The expansion of the types of seat choices reflects the desire of customers to buy levels of comfort that fit their budget while airlines can price the differences between seats at small enough gradients to encourage customers to buy up to the next level. Delta has been more transparent about the financial results from its product segmentation strategy and says that more than half of its passenger revenue across its network comes from its Comfort+ (extra legroom economy) or higher cabins. Delta also says that 70% of customers that try an upgraded product will buy that product again, indicating that there is enormous opportunity for the US3 to enhance their international revenues via premium seats and service, esp. as airlines offer longer flights.

United Premium Plus on the 787-10United Premium Plus on the 787-10 Source: USA Today

Fleet strategies

Delta’s international fleet strategies differ considerably from American’s and United’s. American and United were both early adopters of both the Boeing (NYSE:BA) 777 and 787; American’s 777 fleet numbers near 70 aircraft while United’s is just under 100 – across multiple models. Both each have more than 40 787s in service with AAL’s orderbook exceeding UAL’s for the type. American also has a fleet of Airbus (OTCPK:EADSY) A330s acquired as part of its merger with USAirways.

United is also a large Boeing 767 operator, using the type predominantly across the Atlantic, while American has said it will eliminate the 767 from its fleet during the next two years, to be replaced by the 787 as well as long range versions of the narrowbody A321 with new generation engines. United stunned the aviation community recently by ordering 50 of Airbus’ long range A321s since United has not taken delivery of a new Airbus aircraft for decades and currently has an all-Boeing widebody fleet. Its A321 transatlantic fleet is to replace its narrowbody Boeing 757s; Boeing’s only narrowbody aircraft is the 737 and even in the most extended range models does not have the range to cross the Atlantic in a standard passenger configuration. United has an order for 45 long-range Airbus A350s on order but deferred delivery of those aircraft until the late 2020s, extending the life of its 777-200ERs. Among current widebody aircraft in the U.S. international fleet, the 777-200ERs, of which AAL and UAL have fleets of 47 and 55 respectively, are the least fuel-efficient aircraft on a per seat basis. Delta has 18 777-200ER/LRs; the – LR is the highest performance large aircraft available and allows ultra long haul flights for Delta such as from Johannesburg to Atlanta. Given that newer engine technology matters the most on long flights, American and United’s large 777 fleets will negatively impact those two carriers’ financial results as the 777-200ER is increasingly replaced by airlines around the world.

With its early international network much more heavily focused on Europe, Delta has the largest fleet of 767s in the world, as well as of the 757, which is predominantly used in N. America. Delta, like American, was an all-Boeing airline until its merger with Northwest when Delta gained a fleet of Airbus A330 aircraft, although its Boeing fleet still carries the majority of its passengers around the world. Seeking an alternative to the B787 which should have been delivered to Northwest before the merger, Delta challenged Airbus to build a new-engine version of the A330 and Delta has now ordered nearly three dozen A330NEOs (new engine version) with the first copies flying some of Delta’s Pacific routes. Delta chose Airbus’ new generation international aircraft in part because Rolls-Royce, which provides engines for the A330NEO and A350, gave Delta Tech Ops a contract worth billions of dollars for servicing hundreds of those engines (as well as some engines for the 787) for other airlines. Delta inherited several in-service A350s as well as orders for 10 additional aircraft as part of its deal with Latam. Rolls-Royce is developing an even more enhanced engine, to be fitted first for the A350, that could make the A350 the most fuel-efficient large aircraft when it enters service later this decade.

American A321XLRAmerican A321XLR source: Airbus

The Boeing NMA

Delta has repeatedly asked Boeing to build an all-new small transatlantic widebody to replace its 767 fleet over the next decade; United and American have also expressed interest in the Boeing NMA (New Middle Market Aircraft) but have been less vocal and also have begun to replace their transatlantic 767s and 757s while Delta has not. While Boeing has not finalized design of an NMA or received board approval to offer one, they have provided some indications of design features in a potential NMA. Delta says both the smallest versions of the B787 and A330 are too large and too heavy as replacements for the 767, limiting fuel efficiency improvements. Delta also says that widebody aircraft provide higher levels of passenger comfort that are necessary as Delta continues to grow as a premium airline. Delta has said that it does not believe that use of a narrowbody aircraft across the Atlantic is in Delta’s best interest, differing with American and United and making it unlikely that Delta will choose to fly the A321 over the Atlantic, in part because labor costs on narrowbody transatlantic aircraft will be considerably higher per passenger than on widebody aircraft.

Boeing NMA Design ConceptsBoeing NMA Design Concepts as of 2017. Source. The Air Current

Boeing NMA graphic with design elementsBoeing NMA/797 design elements Source: The Air Current

Delta does not have Boeing widebody aircraft on order but has the largest fleet of one of its most successful models, the 767, and wants Boeing to commit to a new generation small widebody while American and United have committed to replacing some of their Boeing transatlantic aircraft with Airbus products. Because the MAX grounding has shifted Boeing’s attention away from the rest of its product line, a response to the need for a new generation small widebody has taken a backseat to the need to rebuild Boeing’s product line from the 787 down. Airbus has easily won sales contests for the large narrowbody category (the A321 vs. large versions of the MAX). Airbus also gained control of the all-new Bombardier C Series which, rebranded as the A220, has been the leading aircraft in the small narrowbody mainline category. While it is unclear how Boeing might respond to the redevelopment of its product line, Delta’s continued interest in a new small widebody is encouraging for Boeing’s future. At the Consumer Electronics Show, Delta’s CEO encouraged Boeing to keep the future in mind and push forward with development of a new generation small widebody.

Investor impact of Delta and United’s international growth

DAL and UAL both reached their 52 week highs during July 2019. DAL is currently trading at 93% of its 52 week high while UAL is trading at 92%. Including its dividend, DAL traded at par with the DJIA for 2019.

Analyst recommendations for DAL have strengthened in the past month while UAL has weakened. Both carry average price targets at least 10% above their current price. Based on multiple models, DAL and UAL still have considerable room for growth.

DAL recommendations

DAL recommendations Source: Yahoo finance

UAL recommendations Source: Yahoo finance

International growth is a key strategy for both Delta and United. Notably, for both DAL and UAL, international growth is not dependent on resolution of the MAX crisis; while DAL does not operate the MAX, UAL does but began acquiring used domestic aircraft as part of its growth strategy even before the MAX grounding.

Despite ongoing risk and turbulence in international markets, Delta and United have demonstrated they can grow their international networks and revenues and both are able to generate strong profits on at least parts of their network, with smaller annualized profits in other parts, predominantly the Pacific at this time.

DAL and UAL merit investor consideration for many reasons. The strength in their international networks and the expected growth, including the ability to navigate geopolitical risks makes both elements of a healthy portfolio.

Disclosure: I am/we are long DAL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.