MIAMI — Delta Air Lines posted a massive $2.35 billion pre-tax profit in the second quarter (Q2) of 2016, just a tick below the figure of $2.36 billion in Q2 2015. The Atlanta-based carrier was joined in profits by full-service rival United, who announced a much smaller figure of $937 million, down a noticeable 22.2% year-over-year (YOY).

Still optimism was tempered in the face of substantial revenue and unit revenue erosion for both companies.

Delta Earnings Highlights

  • Operating Revenue of $10.45 billion, down 2.4% YOY
    • Passenger revenue down 1.8% YOY to $8.97 billion, cargo revenue down 20.3% YOY to $165 million
  • Operating Expenses of $8.02 billion, down 2.5% YOY
    • Labor expenses up 8.0% YOY to $2.39 billion
    • Fuel expenses down 15.7% YOY to $1.23 billion
    • Maintenance Expenses down 10.6% YOY to $446 million
    • Profit sharing down 21.2% to $324 million
  • Operating Profit of $2.43 billion; operating margin of 23.2% vs. 23.1% in Q2 2015
  • GAAP Net Income of $1.55 billion
  • Capacity up 3.2% in available seat miles (ASMs), demand up 3.0% in revenue passenger miles (RPMs)
    • Load factor down 0.1 percentage points to 85.5%
  • Unit revenue per ASM (PRASM) down 4.9% to 13.59 cents, cost per ASM (CASM) down 5.6% to 12.16 cents, CASM excluding fuel down 0.1% to 9.54 cents

Notes and Observations from Delta’s Quarterly Earnings Call

Delta’s operational excellence continues to pace the industry, with 99.95% completion factor in Q2, and 71/90 days with zero mainline cancellations. In fact, Delta saw 23 days of zero system cancellations including Delta Connection carriers, and the mainline on time performance (OTP) jumped 1.5 percentage points to 86.9%.

Net promoter scores are at record high and customer complaints are down 14% year-to-date. We don’t even have much commentary here: Delta is absolutely setting the gold standard in the U.S. airline industry right now.

One key theme that emerged out of the carrier’s quarterly earnings call was a tonal shift towards further capacity restraint (also known as seppuku for profits). Delta CEO Ed Bastian noted that Brexit pushed Delta to cut IATA Winter Season (October – March) capacity to the U.K. by about 6 percentage points.

Overall, this will remove an additional percentage point of capacity from Delta’s system in Q4, dropping capacity growth in that period to 1% YOY.

Bastian struck a conciliatory tone in discussing RASM during the earnings call. “I want to stress to you that the company is very focused on getting back to positive RASM growth,” said Bastian. “We expect July and August monthly RASM results to be weak.

However, we are anticipating a market improvement in our September monthly numbers as we implement our capacity changes and see benefits from our domestic revenue management initiatives and easing of foreign exchange headwinds and an improvement in the overall pricing environment.”

Once again, a major airline executive has been forced to kowtow to Wall Street’s inane stance on needing to see PRASM growth. Nearly every major investor has held the line on capacity growth despite the vast evidence to the contrary, reacting punitively against airline stocks when they don’t get that wish. As we have said before and will continue to shout from the rooftops, this is idiotic.

In the present environment, lower RASM and lower margins (as long as they’re not funded on additional capital) expand profits and cash flows. Here’s Bastian a few moments later in the call: “All that said, our results for the third quarter should be a record as we expect to generate a pre-tax margin of 20%.”

Airline investors should be rejoicing from the rooftops right now — the US airline industry is in a rare scenario where everyone, management, employees, investors (using free cash flow, a true measure of value accrued), and passengers are better off.

Here are some additional observations from the call:

  • Basic economy has been rolled out to 7,000 domestic markets, or 50% of Delta’s domestic revenue base.
  • Latin America unit revenues were positive for the first time in 26 months, due to a muted 4% decline in Brazil PRASM after Delta pulled 25% of capacity in that market. In the Pacific, PRASM declined 5%, while in the Trans-Atlantic business, unit revenues dropped 4.5%.
  • Delta’s Glen Hauenstein says that corporate demand is “flattish”
  • Delta expects its joint venture with Aeromexico to be approved in Q4
  • The reduction in the Pound’s value has eroded some point of sale demand from the United Kingdom

United Earnings Highlights

  • Operating Revenue of $9.40 billion, down 5.2% YOY
  •         Passenger revenue down 6.6% YOY to $8.10 billion, cargo revenue down 9.2% YOY to $208 million
  •     Operating Expenses of $8.33 billion, down 1.6% YOY
  •         Labor expenses up 5.6% YOY to $2.59 billion
  •         Fuel expenses down 31.8% YOY to $1.44 billion
  •         Aircraft rent down 9.8% YOY to $175 million
  •         Regional capacity purchase fees down 5.5% to $551 million
  •     Operating Profit of $1.06 billion; operating margin of 11.3% vs. 14.6% in Q2 2015
  •     GAAP Net Income of $588 million
  •     Capacity up 0.1% in available seat miles (ASMs), demand down 0.5% in revenue passenger miles (RPMs)
  •         Load factor down 0.4 percentage points to 83.5%
  •     Unit revenue per ASM (PRASM) down 6.6% to 12.52 cents, cost per ASM (CASM) down 1.6% to 12.88 cents, CASM excluding fuel and special charges up 2.6% to 9.90 cents

Notes and Observations from United’s Quarterly Earnings Call

While Wall Street was optimistic after listening to United’s earnings call, for us the quarterly results just highlighted again the gap between United and its peers. Pre-tax earnings excluding special charges did jump by about $500 million but United’s operating margin was down 3.3% with no abatement from revenue pressures in sight.

There were some positive steps during the quarter, the tentative agreement with flight attendants being a huge one. And United’s OTP did jump 11.4 percentage points to 67.9% while completion ticked up from 97.4% to 98.3%. But that’s still 67.9%, abysmal by the standards of almost any airline save those plying China’s choked skies.

United has trouble on both the revenue and cost sides of the ledger, and the Q3 PRASM projections (5.5% to 7.5% in both domestic and international markets) do not inspire confidence. Digging into the region specific performance, we are positive on the moves in the domestic entity to emphasize San Francisco and Denver while pulling capacity out of Houston.

The Trans-Atlantic entity should see some more capacity pulled out due to Brexit, as the 1-2% decline in Q4 feels low for a seasonal business like United.

United expects Beijing and Shanghai capacity growth across the Pacific to slow in 2017 after bilateral caps are reached. But we project that said caps will be renegotiated upwards soon after being hit. Finally in Latin America, Q4 capacity down 5-10% feels right and reduced Brazil seats paired with improved Olympic bookings are a positive sign.

Overall, we are bullish on United’s strategy approach with its various business units.