The devil is in the details. Despite some mixed-headline numbers from Delta Air Lines' (NYSE: DAL) latest investor update, one aspect of management's commentary is bullish for the company and much of the industry. Here's an unpacking of what management says and why you can feel more comfortable holding the stock afterward.
Mixed-headline numbers
For those investors unaware of summer events, airlines suffered flight delays and cancellations due to a CrowdStrike software update that crashed Microsoft operating systems. Delta Air Lines was particularly badly hit, impacting its revenue and earnings lines.
Investors need to account for the impact (hopefully, a one-off issue) when gauging the company's third-quarter performance and full-year guidance. In doing so, it's clear that two of the three key-operating metrics the airline guides toward align with prior guidance; but one, cost-per-available seat mile (CASM-Ex) adjusted for fuel, is slightly disappointing.
The table below shows that the midpoint of the implied guidance excluding CrowdStrike (fourth column) is 3%, the same as the guidance given in the Q2 earnings presentations. Similarly, implied guidance excluding CrowdStrike is similar for available seat miles.
However, the implied guidance for CASM-Ex is higher than the prior estimate. While a difference of 2.5% compared to 1% to 2% may not appear to be a big deal, it's a closely followed number in the industry, and increasing CASM-Ex will decrease profit margins.
Image source: Getty Images.
That's one reason the stock sold off initially after the recent trading update on the Morgan Stanley Laguna Conference. The other reason is that management told investors that its full-year earnings per share would be at the midpoint or above the initial guidance of $6 to $7 when excluding the $0.45 impact from CrowdStrike.
On balance, guidance for underlying earnings at the midpoint of prior guidance, but with costs (CASM-Ex) rising more than expected, is a slight overall negative.
Delta Air Lines Third Quarter | Prior Guidance | Current Guidance | CrowdStrike Impact | Implied Guidance Excluding CrowdStrike |
|---|---|---|---|---|
Total Revenue Growth (YoY) | 2% to 4% | Flat to 1% | Reduced by 2.5 bp | 2.5% to 3.5% |
Available Seat-Miles Growth (YoY) | 5% to 6% | 4% | Reduced by 1.5 bp | 5.5% |
Adjusted Cost per- Available Seat-Mile Growth (YoY) | 1% to 2% | 5.5% | Increased by 3bp | 2.5% |
Data source: Delta Air Lines presentations. YoY is year over year. Bp is basis points where 100bp=1%.
Why investors should warm to the update
As alluded to earlier, the trading update was very positive and helped derisk the stock. I'm referring to management's discussion over capacity curtailments in the industry.
This is a huge deal in the industry and strikes to the heart of the bull-and-bear debate over stocks like Delta Air Lines. The bears see an industry traditionally inflicted with cycles of rapid capacity expansion as travel demand improves and ticket prices rise, only to lead to a slump in profits as demand tails off and airlines stubbornly resist capacity reductions.
Image source: Getty Images.
As such, when the industry moved to overcapacity in the summer, the bears leaped to catch the salmon, while bulls slumbered in the corner, muttering glumly that it would be different this time. Airlines would be disciplined enough to cut unprofitable capacity.
A red flag waving at the bull
The excellent news is Delta President Glenn Hauenstein told investors the excess capacity in the summer "started resolving itself in August and heading into the fall, the off-peak season," and Delta had "inflection of unit revenues in two of our largest entities," namely, domestic and transatlantic routes. In plain English, Delta's revenue per-available seat-miles (RASM) growth is trending upward, which implies the overcapacity issue is improving.
Moreover, investors can take heart from the commentary of United Airlines(NASDAQ: UAL) CFO Mike Leskinen at the same conference when he outlined, "We expected a positive inflection in RASM and domestic and Atlantic in August. We saw that. We talked very proactively and positively about what was going to happen in September, a continuation of that trend. We're seeing that.
Image source: Getty Images.
What it means to investors
In a nutshell, the commentary from Delta and United suggests airlines have taken a disciplined approach in reducing unprofitable capacity, which is improving RASM for both airlines. Moreover, if this behavioral pattern reflects a new normal in the industry, higher-quality operators like Delta could be on the path to long-term growth.
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Lee Samaha has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends CrowdStrike. The Motley Fool recommends Delta Air Lines. The Motley Fool has a disclosure policy.
