Delta Posts Excellent Fourth Quarter and Full Year 2013 Earnings Results; Analysis

By Vinay Bhaskara / Published January 21, 2014

A Delta 767-300 lands at New York – JFK

Earlier today, Atlanta-based legacy carrier Delta Air Lines reported a net profit of $558 million or $0.65 per share excluding special items. The exceptionally strong quarter lead into a calendar year 2013 net profit of $2.7 billion ($3.15 per share) excluding special items, up 68.8% year-over year from a net profit of $1.6 billion ($1.88 per share) in calendar year 2012.

The profit was driven by both increases in operating revenue and strong cost discipline by the carrier. Operating revenues increased 3%, or $1.1 billion year-over-year (YOY), to $37.77 billion thanks to a 3.7% increase in passenger revenues to $32.94 billion. The passenger revenue data strongly reflects Delta’s capacity shift away from 50 seat regional jets (RJs) to larger RJs and small mainline aircraft such as the Boeing 717. Regional carrier revenue declined 2.6% to $6.41 billion, while mainline revenue increased 5.4% to $26.53 billion.

Gotta fill those seats…

Digging further into the revenue data, yields increased 2.6 cents to 16.89 cents per passenger mile. Passenger revenue per available seat mile (PRASM), which includes ancillary revenues such as checked baggage fess and change fees, increased a relatively modest 2.7% YOY to 14.15 cents. However, it is important to note that over the previous three calendar years, Delta had delivered industry-leading PRASM improvements, and today has by far the highest PRASM (adjusted for stage length) amongst US carriers. Capacity measured in available seat miles (ASMs) grew a modest 1.0%, reflecting Delta’s position of industry leading capacity discipline which has solidified its position as the most profitable US airline (in absolute terms).

Region by region revenue performance broke down as follows:

Region	Change in PRASM 4Q 2013 (%)	4Q 2012 RASM (cents)	4Q 2012 CASM (cents)	4Q 2012 Operating Margin (%)	4Q 2013 Projected Operating Margin (%)
Atlantic	0.1%	12.00	13.71	-12.4%	(-12.5) to (-11.8)%
Pacific	-2.2%	14.20	13.85	14.1%	13.5 to 14.3%
Latin America	1.9%	13.82	12.90	7.1%	6.8 to 7.6%

The challenges in the Pacific were mainly driven by the weakness of the Japanese Yen due to the Abenomics economic program of Prime Minister Shinzo Abe. The Tokyo Narita hub represents more than 60% of Delta’s Pacific region capacity. Japanese originating demand was reduced in both absolute terms and real terms by the devaluation of the Yen from the Bank of Japan. This effect will likely persist into 2013 as the US Federal Reserve continues to taper its quantitative easing purchase program (thereby stabilizing the value of the dollar) and the Bank of Japan devalues the Yen more aggressively, which will cause fares to and from Japan to decline in terms of dollars.

However, thanks to its growing presence in direct flights between Seattle and secondary Asian cities, Delta has a hedge against further declines in the Yen over the long term, though the immediate effect will be to put further downward pressure on Pacific PRASM in 2014 as Delta’s network ingests the new routes.

A Delta Airbus A330 sits at the gate at SeaTac International Airport.

The trans-Atlantic market is always weak during the fourth quarter as tourist demand largely evaporates. However, the losses during the period are more than offset by the fantastic margins earned during the high season (Q3), which also has nearly 30% more capacity thanks to seasonal routes. For example, in the third quarter of 2013, Delta’s operating margin on trans-Atlantic routes was an incredible 23.2%. The reverse holds true for Latin America. The fourth (and first) quarters are its strongest periods, with the second and third quarters serving as the low season.

On the expenses side of the ledger,  full year operating expenses held effectively steady at $34.37 billion versus $34.5 billion a year earlier. In particular, fuel costs decreased a handy 7.4% YOY to $9.40 billion, helped by the effects of the much maligned Trainer Refinery, which reduced the crack spread (the price difference between equivalent amounts of jet fuel and crude petroleum) and drove down Delta’s price per gallon of jet fuel to $3.09 for the full year.

Operations at Trainer did, however, produce a $116 million net loss for the full year, and it’s important to note that every airline (United, Spirit, all of them) benefit from the reduction of the crack spread  and reduction of jet fuel prices, while Delta is the only airline that incurs any cost for this effect. The reduction in fuel expenses for the full year was also driven by improvements in fleet mix; retiring fuel-inefficient 50 seat RJs and Douglas DC 9s in favor of larger RJs and Boeing 717s.

The major increases on the expense side were employee driven; salaries increased 6.4% YOY to $7.72 billion reflecting increased workforce seniority and more generous labor contracts. And in another positive item of note, profit sharing payments increased 36.0% YOY to $506 million, providing some measure of validation for Delta employees that chose to reject unionization post-merger. On a per-ASM basis, Delta’s full year cost per ASM (CASM) decreased 0.5% YOY to 13.81 cents thanks to the reduction in fuel costs, while CASM excluding fuel increased 3.1% YOY to 8.44 cents due to the increases in employee costs.

Turning to the balance sheet, Delta ended the year with $3.93 billion in cash and short term investments, up from $3.75 billion at the end of 2012. Delta’s net debt declined to $9.4 billion at the end of the year, down more than $1 billion YOY as Delta continues to reduce its debt load to industry leading levels. This debt reduction was certainly helped by Delta’s modest capital expenditure program of $2.52 billion for the full year, as Delta’s fleet strategy of relying on secondhand aircraft, new build aircraft at the end of production cycles, and refurbishment of the existing fleet paid off. Thanks especially to this focus on limiting CapEx, Delta’s free cash flow (often the most important figure for investors in evaluating a company’s valuation), was a healthy $2.1 billion, more than $1.0 billion greater than projections for its US airline peers.

Most of this free cash went towards the aforementioned debt reduction, with the remainder distributed between $250 million in excess pension contributions for employees, increases in the company’s cash position, and $350 million in cash returned to shareholders as a combination of $250 million in share repurchases and $100 million in quarterly dividends. The last item is of particular import, as Delta is the first US legacy carrier to be in a position to return cash to shareholders on a consistent basis.

The final item of note is that Delta actually made a net profit (according to generally accepted accounting principles [GAAP]) of $10.54 billion for full year 2013, and $8.48 billion in the fourth quarter alone (including special items). The reason for this net profit is essentially the value of tax loss provisions. Whenever a corporation loses money for a fiscal year, the IRS gives it a tax loss provision, which allows the company to reduce the tax rate it pays in future years because it lost money in the current year. The value of this provision is typically carried on a company’s books as an asset. However, if a company looks like it is going to continue losing money (or making very little money) for an extended duration, its accountants might decide that the provision will be worthless, and then write the asset off (eliminate it from the company’s books by taking a paper net loss equivalent to the value of the asset).

In Delta’s case, if you think back to 2008 when it was unclear whether the company would ever be consistently profitable, the company wrote off $7.9 billion in tax provision benefits on its way to a $8.99 billion net loss for that calendar year. However, since Delta is now making consistently large profits, that tax value provision now holds incredible value (instead of making payments in cash to the IRS, Delta can instead deduct its income tax from that provision). But in order to take advantage of that provision, Delta had to add it back onto its books (adding roughly $7.9 billion in net profit for the fourth quarter in order to do so).

So in summary, Delta Air Lines once again outperformed its US carrier peers (a certainty even though the remaining carriers have not reported), delivering fantastic results for the fourth quarter and full year 2013.

Edited by Jeremy Dwyer-Lindgren

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