Delta Air Lines, Inc. Gets Closer to a Revenue Recovery

The United States' three big global airlines -- American Airlines , Delta Air Lines , and United Continental -- have all reported declining unit revenue during 2015.

This unit revenue weakness has three main causes. First, because all three sell many tickets for international flights in foreign currencies, the strong dollar has negatively affected unit revenue. Second, a number of countries (particularly in Asia) have mechanistic fuel surcharges that follow jet fuel prices. As a result, the drop in jet fuel prices since mid-2014 has reduced unit revenue. Third, rising competition has driven down fares in several markets.

A variety of factors have led to unit revenue declines at the legacy carriers. Photo: The Motley Fool

American, Delta, and United all recognize that they can't rely on fuel prices continuing to fall. In order to maintain their high profit margins, they will need to get back to unit revenue growth: preferably sooner rather than later. This has led to a "race" of sorts to improve unit revenue -- and Delta is winning.

Delta has a clear planWhile Delta, American, and United have all outlined steps that could help bolster unit revenue, Delta has by far the clearest plan. First, it has broadly rolled out "branded fares" that allow it to better segment its customer base. (That's airline-speak for selling tickets at different prices to different customers, depending on how much they are willing to pay.)

The crux of this strategy has been the introduction of "Basic Economy" fares that Delta uses to match ultra-low cost carriers' fares. Basic Economy tickets don't include seat assignments or any flexibility for flight changes or upgrades. Highly price-sensitive customers buy these tickets, but most Delta customers voluntarily pay more for a Main Cabin fare with fewer restrictions.

Meanwhile, Delta is aggressively slashing capacity in weak international markets. Back in April, the carrier announced that it would reduce international capacity by 3% year over year beginning with its winter schedule, with cuts focused in Japan, Brazil, Russia, Africa, India, and the Middle East. By October, it had increased the scope of its capacity cuts, projecting a 4.5% year-over-year reduction in international capacity for Q4.

United and American face big challengesBy contrast, American Airlines' most recent plan calls for 0%-1% international capacity growth in Q4 and 4%-6% international capacity growth in 2016. It has already dramatically cut capacity to Brazil, one of its top international markets, but results remain terrible there, as the Brazilian real has fallen precipitously against the dollar this year and the economy has tilted into recession.

American Airlines is growing international capacity despite unit revenue pressures. Photo: American Airlines

American Airlines executives have indicated that they aren't willing to cut any further in Brazil for now. They have also stressed the need to keep growing in the transpacific market, where American is much weaker than United and Delta. American also faces the most direct competition from budget carriers. These factors will probably lead to further unit revenue declines for at least a few more quarters.

As for United Continental, it expects modest capacity reductions in the Atlantic and Pacific regions to be more than offset by growth in Latin America during Q4. It's also planning 2%-3% growth in international capacity for 2016.

Like American Airlines in Brazil, United is holding the line on capacity in China even as unit revenue has come under pressure there. Rapid capacity growth by Chinese carriers has thrown the market out of balance, and United has opted to wait things out rather than risk damaging its leading market share in China. United's unique exposure to the oil industry through its Houston hub isn't helping its unit revenue, either.

Capacity cuts are already driving results at DeltaDelta's international capacity cuts went into effect at the beginning of October and are already shoring up its unit revenue. International capacity declined 3.9% year over year last month, with most of the cuts concentrated in the Pacific region (primarily Japan). As a result, Delta estimates that passenger revenue per available seat mile (PRASM) declined just 1% year over year.

Delta's unit revenue nearly reached the flat line last month. Photo: The Motley Fool

Last month, Delta's management projected that PRASM would decline 2.5%-4.5% year over year in Q4, with November being the best month, December being the worst, and October somewhere in between. The carrier's strong October performance makes that guidance seem conservative, though.

It's true that the timing of Thanksgiving and Christmas compared to last year will dampen airlines' December unit revenue. However, with October PRASM being down just 1% and November PRASM potentially being flat or better, even a mid-high single digit PRASM decline in December would leave Delta at or above the top end of its guidance range.

That's likely to put Delta well ahead of its competitors in the quest to return to unit revenue growth. United Continental has projected that PRASM will decline 4%-6% year over year in Q4, while American Airlines expects a 5%-7% drop.

Delta's improving unit revenue trajectory puts it on pace to get its unit revenue performance to the flat line in the first half of 2015 and into positive territory by the middle of the year. The recovery is likely to take a little longer at American Airlines and United Continental.

The article Delta Air Lines, Inc. Gets Closer to a Revenue Recovery originally appeared on Fool.com.

Adam Levine-Weinberg owns shares of United Continental Holdings, and is long November 2015 $40 calls on American Airlines Group and long January 2017 $40 calls on Delta Air Lines, The Motley Fool is long January 2017 $35 calls on American Airlines Group. 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.