Delta Air Lines, reported solid Q1 earnings growth last week, with EPS rising to $0.45: up from $0.33 in the year-earlier period. As good as the results were, they would have been even more impressive but for Delta's $1.1 billion in fuel hedging losses.
Delta posted solid EPS growth in Q1 despite its massive hedging losses. Photo: The Motley Fool
Following the earnings release, Delta executives spent an hour talking with analysts and the media about the company's results and the outlook for the rest of 2015. Here are 5 key points they emphasized.
The strong dollar is hurting revenue
Like its legacy carrier peers, Delta devotes a significant proportion of its capacity to international flights, and many of those tickets are purchased abroad. As a result, its revenue is being pinched by the strong dollar, which has appreciated dramatically against numerous currencies across the world, including the euro, yen, and real.
When Delta sells tickets in those foreign currencies, it now gets less revenue upon converting the cash back to dollars. This is on pace to shave $600 million off Delta's top line this year: roughly 1.5% of its annual revenue. Including the impact of falling fuel surcharges -- mainly on Asian routes -- Delta is facing a $1 billion revenue hit on its international routes.
But it's helping on the cost side
While the strong dollar is bad for revenue, it's very good for costs. First, the strong dollar has contributed to the huge drop in oil prices since last summer, which is projected to save Delta more than $2 billion this year.
Second, Delta incurs costs essentially everywhere it operates, including labor, ground handling costs, airport fees, and navigation charges. The strong dollar is reducing the dollar amount of Delta's foreign expenses. In Q1, that produced a 1 percentage point tailwind for Delta's non-fuel unit costs.
Capacity discipline remains
While Delta is posting excellent overall results despite its international revenue weakness, the company's management is not satisfied with the status quo. As a result, it announced plans to slash its international capacity significantly after Labor Day, primarily in Japan, Brazil, Africa, India, and the Middle East. It will also suspend its service to Moscow for the winter season.
Rather than dropping routes entirely, Delta plans to reduce capacity by using smaller planes and in some cases by flying less frequently.
Delta will target its cuts at the routes that have been hurt the most by the strong dollar, such as flights from Japan to beach markets like Hawaii. Delta has also stated that it will remove 6 more Boeing 747s from its fleet this year, so routes currently served by the 747 are most at risk.
Fuel hedging headwinds will recede
Delta posted solid earnings growth last quarter, but it was nothing close to the performance it would have achieved if it hadn't faced massive fuel hedging losses. Due to the falling price of crude oil and the company's decision to reduce its hedging exposure for the second half of 2015, Delta had to swallow $1.1 billion in hedging losses last quarter.
Delta expects to lose another $650 million on its hedges in Q2, but for the whole second half of 2015 it's projecting hedge losses of just $300 million. This will lead to a significantly lower "all-in" fuel price, sending up to $1.5 billion in fuel cost savings to the bottom line in the second half of the year.
Long-term capital structure plans coming soon
The big drop in oil prices is creating a massive tailwind for Delta's already strong profitability and cash flow. In fact, the company expects to produce $4 billion-$5 billion in free cash flow this year.
This raises a big question: what should Delta do with all of this cash? While the company started paying a dividend and buying back some stock 2 years ago, it has used most of its cash flow to reduce its net debt burden by $10 billion over the last 5 years.
Delta will present its longer-term capital structure plans at an investor meeting next month. On the earnings call, CEO Richard Anderson implied that Delta may be close to reaching its optimal long-term debt target. If so, it could be on the verge of using its strong free cash flow to fund big increases in its dividend and share buyback plans. That's a welcome prospect for any Delta shareholder.
The article 5 Things Delta Air Lines, Inc. Management Wants You to Know originally appeared on Fool.com.
Adam Levine-Weinberg is long January 2017 $40 calls on Delta Air Lines, The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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