Delta Air Lines Is Pandemic Proven To Be The Global Leader

Summary

• Since the covid era began, Delta has worked to minimize cash burn, reduce costs, and maximize revenue generation.
• Delta had the opportunity as the covid era began to increase its competitive advantages relative to its competitors.
• Delta has managed its recovery to limit stock dilution.

Photo by franckreporter/iStock Unreleased via Getty Images

One year ago, the airline industry was digesting the deep drop in demand that accompanied the arrival of the covid-19 crisis and with it the desperate need for airlines to raise capital, cut costs, and maximize whatever revenue they could obtain. Although the number of passengers that passed through TSA checkpoints fell to the lowest levels in decades just 51 weeks ago, the rebound in traffic over the past two months has been dramatic with the TSA reporting that passengers are now sustained at about 65% of 2019 levels for the same day of the week. As the U.S. approaches 20% of the population fully vaccinated and new vaccinations occurring equivalent to the rate of nearly 1% of the U.S. population every day and as case and death counts fall, Americans are increasingly ready to re-engage in the year of travel that was taken from them by the pandemic. It was a given that the airline industry would be significantly damaged by the covid-19 crisis and that has certainly been the case.

In May of 2020, I wrote here on Seeking Alpha that Delta Air Lines (NYSE:DAL) was executing the best recovery plan. A year later, and just days before Delta kicks off the 1^st quarter 2021 earnings season, it is worth reviewing Delta’s performance over the past year, esp. relative to its competitors. Three primary areas – network and competitive positioning, personnel and fleet, and financial position – will provide valuable perspectives into Delta’s performance over the past year and also provide insight into its potential for continued recovery and stock appreciation.

Source: Delta Air Lines

Network and Competitive Positioning

One of the key components of an airline’s revenue generating ability is its network of routes. Delta spent the past ten years building one of the strongest and most unique route systems among global airlines. As a result of its 2009 merger with Northwest Airlines, Delta operates hubs across the United States and has a leadership position in many of the world’s largest international travel markets. Delta entered the covid era with the highest market share in its hubs and focus cities among the big 3 global U.S. carriers; Southwest has higher market share at its largest airports – but many of those are secondary airports in major metropolitan areas. Delta had every reason to not only use the covid era to protect its market share in its major markets but to look for opportunities to grow. While the covid recovery plan is still unfolding at each airline, Delta appears to have not only weathered the covid era better than many of its peers from a network perspective but also is set to expand on its long-term strategic goals.

Delta’s network is anchored by its massive hub at Atlanta, the world’s largest airline hub, its twin Midwest hubs at Detroit and Minneapolis/St. Paul and its Mountain hub at Salt Lake City, where Delta recently occupied the first part of a completely new passenger terminal. Each of these four metro areas have only one commercial airport and Delta has more than a 50% local market revenue share at each airport which helps drive above-average passenger yields across the airline. Delta also operates hubs at both New York LaGuardia and Kennedy airports and at Boston; at the latter two, JetBlue is Delta’s largest competitor while American is the next largest airline at LaGuardia behind Delta. On the west coast, Delta entered the covid era as the second largest airline at both Los Angeles (behind American) and at Seattle (behind Alaska).

As I have previously in this Seeking Alpha article, American Airlines (AAL) has signed strategic partnerships with Alaska Airlines (ALK) on the west coast and with JetBlue (JBLU) in the Northeast in order to help American better compete in markets where it has smaller market shares than Delta or United. American chose to partner with Delta’s largest competitors in all of Delta’s coastal hubs, hoping that the combination of American and either ALK or JBLU would provide the size to compete with Delta. American’s partnerships with ALK and JBLU are not antitrust immunized and do not involve revenue sharing although American does have the ability to jointly plan domestic capacity in the NYC and Boston markets with JBLU. Current schedules indicate that American and JetBlue will individually be smaller than they were pre-covid relative to Delta.

As airlines began to dramatically reduce capacity more than a year ago in order to survive the reduction in demand due to covid, it was clear that some hubs and cities would not return with similar levels of service for all airlines. Looking region by region across the U.S., the Northeast U.S. suffered deep declines in demand during most of the pandemic but has surged in recent weeks as New York State has dropped quarantine requirements. Still, the level of post-pandemic demand from the Northeast including NYC is far from certain based on the large number of people that have left NYC as well as a shift to work from home and New York State and City tax increases, all of which will depress the number of people that return to NYC offices. Although JetBlue’s NYC focus was primarily at JFK airport pre-pandemic, it is hoping to be able to use some of American’s LaGuardia slots and has also added significant amounts of service at Newark airport; the combination of JBLU’s NYC moves not only decreases AAL and JBLU’s individual relative sizes to DAL but also increases price competition at Newark which, combined with additional JBLU capacity at Newark, will weaken United Airlines' (UAL) position in NYC relative to DAL. Based on current schedules, airlines continue to operate well below the number of their pre-covid slots in NYC. It is notable that Delta is operating a larger percentage of pre-covid capacity at JFK than JBLU even though much of Delta’s transatlantic operation is not operating due to transatlantic covid restrictions.

The longer-term prospect for Boston, Delta’s most recently designated hub, is strong as Delta builds its transatlantic network, connects more passengers through its modern facility there, and expands to more long-haul domestic destinations. Mirroring other airlines across the country, JetBlue is reducing higher frequency flights on business-type routes in favor of longer-haul domestic, leisure flights at least through the summer. Delta’s relative position to JBLU in Boston is now stronger given that Delta’s strength comes from its international network as well as its much stronger position to its hubs. As happened before covid, a number of other competitors besides DAL and JBLU are dropping out of some routes, allowing Delta’s position to grow. For example, both Alaska and United have dropped flights from Boston to Los Angeles in May compared to 2019 while American is just one-third of its 2019 size in that market where it once was the largest. From Boston to Seattle, JBLU is not offering service for May, leaving Delta as the largest airline. Summer schedules have not been finalized for all airlines but it is likely that Delta’s relative position to other airlines will be stronger, both because of Delta’s strength on both coasts which other airlines lack and because American will try to mitigate some of its weakness through its partnerships with ALK and JBLU. In 2019, Delta had a 27% revenue share of the local NYC airport (all 3 major airports).

On the west coast, the story is similar but the dynamics are more accentuated. The Bay Area has been one of the slowest markets to return and, compared to NYC, there is a good possibility that there may be an even larger permanent reduction in the size of the air travel market in N. California due to the number of people that are moving out of the area and a greater amount of work from home esp. in the tech and financial sectors. Since United is the largest airline at San Francisco with the largest transpacific hub, Delta’s position on the west coast will become stronger relative to United due to Delta’s twin hubs at Los Angeles and Seattle; Delta trailed United as the second largest west coast airline based on revenue in 2019. American started cancelling its flights from Los Angeles to China even before covid and has failed to publish competitive schedules in a number of domestic markets since covid began. Prior to covid, Delta had approximately 75% of American’s capacity at Los Angeles (LAX) but for the month of May has scheduled 110% of American’s capacity. Delta has overtaken American as the largest carrier in a number of key competitive markets while United and Southwest (LUV) are also relatively smaller than Delta based on current schedules. Delta began an expansion and rebuilding of its terminal facilities at Los Angeles prior to covid and has accelerated that project. In addition to LAX airport itself, Southwest has fallen from the largest airline in the combined Los Angeles Basin airports as a group because Southwest’s high frequency, short to medium-haul network focus in California will likely be much slower to return. Based on current schedule trends, Delta is well-positioned to continue its position as the largest airline at LAX and in the Los Angeles Basin as a whole. Delta has never been the largest airline in both New York City and Los Angeles and a leadership position in both of those large markets will significantly propel Delta’s relevance in the global marketplace in addition to its strength in its core interior hubs.

Delta also operates several domestic focus cities or markets where Delta has a strong position in the top routes from that city but is focused on local market demand rather than connecting traffic as occurs at its large hubs. I previously discussed Delta’s focus city strategy here. Recently, Delta announced it is dropping Cincinnati, a pre-merger Delta hub, as a focus city, although its current schedules show a number of non-hub routes returning, including a planned restart of its flight to Paris. Delta also dropped the focus city designation for Nashville and San Jose, CA, although Delta did not develop those cities prior to covid beyond service to its hubs and other focus cities. While fast-growing, Nashville airport is expected to have a significant gate shortage for years while San Jose will likely be a much smaller market due to work from home practices in the tech sector. Delta did retain its focus city designation at Austin, Texas where its current schedules show that it has displaced United as the third largest airline. Also fast growing, Austin expanded facilities recently and Delta gained access to gates which should allow it to grow. Southwest’s position in Austin will be smaller because of the reduced amount of short-haul demand while American is vying to grow its second-place position in Austin, launching new flights to a number of cities with Southwest as the most targeted carrier by American’s expansion. As it has done throughout the pandemic, Delta is likely to wait until the market is more stable to announce its plans for Austin with growth potential for any airlines in the Heart of Texas limited by their ability to access gates.

South Florida has become a major industry focus with an influx of new residents as well as business relocations. American’s Miami hub has seen expansion and new service from Southwest and JetBlue, the latter of which is adding service in major markets such as to Los Angeles, resulting in a plethora of low fares. Although its capacity has grown, Delta has played relatively low in Miami despite its pre-covid intention of building a network at the S. Florida city to feed flights for its partner Latam. Given that covid has reduced demand to/from Latin America and Latam is reorganizing under Chapter 11 bankruptcy, Delta seems to be delaying its expansion in Miami while the low-cost environment at Miami stabilizes and until the international travel market at Miami returns. Interestingly, both Southwest and JetBlue have reduced their presence at Ft. Lauderdale presumably to fund their expansions at Miami, even as Spirit (SAVE) and Delta have expanded, leaving Delta with a larger share. Delta has long been the largest of the big 3 carriers at Ft. Lauderdale and could expand its presence in both Miami and Ft. Lauderdale as the market recovers, including with the return of cruises which require a substantial amount of air service at airports that serve as cruise line bases.

On an industry basis, there has been a shift toward leisure markets and away from high frequency business markets. With its strong position to Florida and the Caribbean, Delta has been well-positioned to compete with its existing network. Several other airlines added a number of leisure routes during the pandemic to try to tap demand but Delta has been remarkable quiet in adding new routes. Only recently has it added a slew of new markets for the summer to Alaska and to airports near national parks, capitalizing on an expected strong domestic travel season for the summer of 2022 with a focus on outdoor leisure.

In total, for the month of May 2021 compared to 2019, on a system wide basis, U.S. airlines will offer 33% less capacity. American, Delta, and Southwest’s capacity are all down about 22% while United’s capacity is down 45%.

If the focus is just on flights to/from N. America (to offset the longhaul international networks of the big 3), AAL and DAL are both down 15%, while ALK, JBLU, and LUV are down 20% and UAL is down 40%. Ultra-low cost carriers such as SAVE and ALGT and the recently listed Frontier (ULCC) have returned nearly all of their 2019 capacity.

Given the size difference between the smaller ULCCs and United and Southwest, it is more significant that American and Delta have returned more capacity than all of the other carriers in the industry except for the ULCCs. Delta has not only returned as much or more capacity in its hubs and focus cities than the industry as an average in those cities but Delta has also returned more capacity in most of its competitors’ hubs and bases. Although many analysts have said throughout the pandemic that the low-cost carriers would lead the return, current schedule data shows that the greatest return in capacity is happening at American and Delta. While American is reducing the size of some of its hubs in favor of outsourcing flights to ALK and JBLU, Delta is maintaining more of its network than any of the big six legacy/global and low-cost carriers and returning a higher percentage of its capacity across each of its major cities than any other big six carrier. Further, all U.S. airlines compete for the same domestic, leisure passenger while longhaul international travel and corporate traffic travels on a smaller subset of industry players.

Finally, it is worth noting that the return of international longhaul markets will provide a revenue boost to the big 3 carriers in contrast to the largely domestic low cost and ULCC carriers. Europe is expected to be the first region to return and Delta is expected to retain its position as the largest airline across the Atlantic. As UAL’s CEO has noted, the amount of low-cost capacity between the U.S. and Europe will be dramatically lower due to the failure of a number of low-cost international airlines which will support a faster return of normal fare levels. Additionally, Delta is adding capacity to its flights to Africa where it has been the largest airline from the U.S. for a number of years. Looking across the Pacific, United was the largest carrier pre-covid but will not be able to return to its previous size because of the relatively slow speed with which many East Asian countries are reopening their borders to foreigners. In addition, China, where United has long been the largest U.S. airline, has imposed covid capacity restrictions although China previously said that its airlines lost $3 billion/year on international routes even before covid. The result is that U.S. airline capacity to China is a shell of its former self and it is far from clear when all previous flights for both U.S. and Chinese carriers will return. As a result of reduced capacity to China and the elimination of U.S. carrier flights to a number of destinations in Asia, Delta is now slightly larger than United from the U.S. to East Asia. Latin America will likely be slow to return as S. America heads into another winter and as covid cases remain very problematic in Brazil, the largest S. American market. Delta’s third place position in the region will not likely change until its joint venture partnership with Latam is approved by all of the countries involved which could happen during the next twelve months. In both domestic and international markets, Delta is well positioned to retain and grow its position in Delta and the industry’s largest markets.

Financial Position

Delta entered the covid era in one of the most enviable positions among global airlines. Deeply indebted after the Great Recession of 2008/09, Delta paid down more than $10 billion in debt and achieved an investment grade credit rating before it embarked on an extensive fleet replacement program in the late 2010s. In addition, in 2019 Delta achieved a net income margin within 1% of Southwest, long considered one of the best-run airlines in the world. Delta’s challenge during the covid era was to prevent losing all of the financial advantages it had built up between the Great Recession and the covid era.

Delta has long had one of the best track records in the airline industry for cost control due in part to its status as one of the least unionized large airlines in the world but also because it is very prudent with spending. Delta challenged industry convention in the 2010s about how long aircraft could last, reducing capital spending while also cutting the cost of performing maintenance on its fleet. Delta never quit buying new aircraft and used its newer, more fuel-efficient aircraft on routes where they produced the greatest advantage while using older, less efficient aircraft on routes where their inefficiencies were less pronounced and then decreasing use of those less efficient aircraft during less peak periods of the year.

Delta’s maintenance strategy evolved to outsource functions that are more costly for U.S. workers to do relative to the global market while retaining highly skilled functions such as engine overhauls. Delta has focused its Technical Operations division on performing tasks which can be sold to other airlines, effectively reducing the cost of maintenance on Delta’s own fleet. Delta won valuable contracts from Pratt and Whitney and Rolls-Royce to service engines for other airlines, gaining long-term revenue that offset large portions of Delta’s own fleet replacement costs. Consequently, Delta’s maintenance costs per available seat mile are some of the lowest among U.S. airlines even though Delta’s fleet was the oldest among U.S. airlines for several years. Delta’s fleet cost advantage is expected to increase as the pandemic recovery accelerates.

As the covid era began, Delta was burning one of the largest amounts of cash among U.S. airlines. That elevated figure was partly due to massive refunds of Spring Break 2020 and summer international travel but the $100 million cash burn/day required Delta to quickly pull down lines of credit and access capital markets. As with other industries, the capital markets for airlines were locked up in the early weeks of the covid pandemic and were reopened with the first CARES Act and action by the Federal Reserve. During 2020, Delta was able to access more than $10 billion from private capital markets in addition to federal funds. By the end of 2020, Delta was expecting to become cash burn neutral in the spring of 2021 and recently stated, along with United, that it expected to have achieved that goal in March 2021. For all of 2020, Delta’s net cash burn was $3.8 billion. Delta will receive nearly $10 billion in federal funding by the time the third round of federal aid is completed; that amount constitutes the vast majority of Delta’s salary and benefit expense which is similar to what is occurring throughout the airline industry.

Delta's FCF Reconciliation Source: DAL 2010 10K page 53

Since the start of 2021, Delta began replacing higher interest debt and paying down loans to return to more than $10 billion in unencumbered assets, a similar level as Southwest but substantially higher than American and United. Delta has said it expects to make a $1 billion contribution to its pension plans in the second quarter of 2021 and begin paying cash for aircraft deliveries later this year.

Delta’s passenger revenues fell by 70% in 2020, with larger declines in their transatlantic and transpacific regions with cargo revenue offsetting some of the passenger declines. Because half of the world’s air cargo normally flies in the bellies of passenger aircraft, cargo rates have remained high, allowing passenger airlines to operate longhaul international flights with very low passenger flights.

Delta's operating revenue Source: Delta 2020 10K page 34

Delta’s refinery swung to a loss in 2020 from a profit in 2019, adding 11 cents/gallon to the price of Delta’s airline fuel cost; for a number of years, the refinery has reduced Delta’s fuel cost on average by five cents/gallon. Delta’s refinery is specifically tuned to produce high percentages of jet fuel so it has reduced capacity even as demand for all fuels in the Northeast U.S., where the refinery is located, has fallen more than for the country as a whole. Delta exchanges non-jet fuel products from its refinery for jet fuel in other parts of its system. As demand for jet fuel returns, the economics of the refinery should improve although the negative operating loss for the refinery was less than for airline operations.

Delta recorded $8.2 billion in restructuring charges, 55% of which were for fleet retirements over the next five years. The largest charge was for the retirement of Delta’s 777 fleet while the largest number of aircraft were its MD-80s and -90s which incurred relatively small charges. Some of the restructuring charges could be reversed by sales of some aircraft. The large restructuring charge will help reduce Delta’s tax liability for years to come, as will be the case for the airline industry as a whole.

DAL restructuring charges Source: Delta 2020 10K page 75

Because the CARES Act provided funding through September 30, 2020, the fourth quarter of 2020 was expected to be the quarter when airlines would have to demonstrate that they had a viable business plan despite the depressed business environment. On a comparative basis, the fourth quarter of 2020 showed that Delta’s efforts to restructure its operation paid dividends relative to the performance of its competitors. Delta’s passenger revenues fell by about the same percentage as other carriers even though Delta blocked the sale of middle seats from the beginning of the pandemic; several other airlines blocked the sale of some seats while others did not ever block seats. Delta was able to generate a significant yield premium – up to 30% over some of its U.S. global competitors - even as its load factor for 2020 was not substantially lower than most of its peers. As demand returns and vaccination rates increase, Delta intends to end seat blocking at the end of April 2021 which will increase its revenue generating capability per flight by up to 50% depending on the aircraft configuration.

Delta was also able to reduce its cost relative to the industry far more than its peers. In the fourth quarter, Delta’s cost per seat mile excluding fuel and special charges was just 5% above Southwest’s but less than three-fourths of AAL and UAL’s levels. If Delta is able to retain even a portion of the revenue and cost advantages it developed during the pandemic relative to American and United, it will be very well positioned to grow in many of the industry’s top markets; conversely, the reduced cost disadvantage low cost carriers have with Delta will disincentivize them from growing in Delta’s strength markets; recent industry capacity changes appear to validate that low cost carrier capacity is growing more outside of Delta’s strength markets rather than in them.

Delta’s Unholy Week

The week between Palm Sunday and Easter proved to be one of the more memorable in Delta’s history and for many of the wrong reasons. After sitting on the sidelines while Georgia, Delta’s home state, drafted a new voting bill and then saying that it supported the bill with its flaws, Delta later joined Coca-Cola in strongly condemning the new voting access law. While consumer boycotts have rarely had much impact on a long-term basis, Delta’s clumsiness in switching sides on the bill/law and its much more vocal position compared to other Georgia companies such as Home Depot and UPS have put Delta at the pointed end of boycott threats from those that would prefer for Delta to focus on running its business. Major League Baseball’s decision to move the All-Star game from Atlanta threatens to slow Georgia’s recovery if the state is caught up in a series of boycotts and counter-boycotts; Delta is the official airline of a number of MLB teams.

To add insult to injury, Delta was forced to cancel more than 70 flights due to crew shortages on Easter Sunday, providing fuel to critics that argued that Delta should focus on running its business. Shockingly, this is the third holiday in six months in which Delta has faced the same problem. While the company has consistently argued that a number of factors including a variety of covid-related issues are at fault, the cancellations have almost entirely occurred on holidays. Pilot chat forums indicate that the problem is caused because Delta has not retrained a sufficient number of pilots as a result of its massive fleet retirements and pilot retirements; normally, pilots are willing to work “overtime” and pick up flights on non-holidays for premium pay but are much less willing to do that on holidays. Given that Delta has promoted its operational reliability, its staffing issues create an unwelcome distraction to Delta’s return to normality.

While both the voting access law and the holiday cancellations could prove to be short-term issues that quickly blow over with the rapid return of air travel demand, they both represent risk that Delta must manage, presenting different challenges for Delta than other airlines are facing.

Delta Stock Performance

DAL’s stock chart shows that my $40 price target from nearly a year ago has been in the rearview mirror for months. DAL stock has encountered resistance at $50 but will likely push past that level in the months ahead. As international demand returns, I believe DAL is well-positioned to take a $60 level. Delta’s stock appreciation is helped because it is one of the few U.S. airlines that has not issued equity (other than warrants to the federal government as required by all airlines that received aid).

Source: Seeking Alpha

Delta Air Lines spent the ten years prior to the covid outbreak building one of the strongest businesses among global airlines. When covid-19 struck, Delta quickly moved to cut costs, maximize the revenues that were available, and worked to protect its balance sheet and repair it at the earliest opportunity. Based on data that is currently available, Delta has improved its competitive position in the industry. As demand recovers, I believe Delta is well-positioned to not only return to its leadership position in the industry but also to increase its advantages relative to its competitors.

Delta will report its first quarter 2021 financial results and release updated guidance later this week.

Analyst’s 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.