Delta Air Lines Makes A Bet On International Travel (NYSE:DAL)

This article is part of a series about the major airlines in the U.S. Please see the following links to my previous articles in this series.

• JETS: The Airlines Are Tradable, Not Investable
• AAL: Operational Efficiencies Need To Produce In 2022
• ALK: Shareholder Returns On The Horizon

The Old Dog With Lots Of Tricks

Delta Air Lines (DAL) is one of the three legacy U.S. carriers to survive the last round of consolidation in the 2000s after acquiring Northwest Airlines in 2008. Headquartered in Atlanta, GA, it operates the largest hub in the world by daily flights at ATL. It also maintains significant operations in New York (JFK), Boston, Detroit, Minneapolis-St. Paul, Salt Lake City, Seattle, and Los Angeles.

Delta has been at the top of the charts in terms of passenger miles flown, revenue, and daily flights since its merger with Northwest and been more profitable than its legacy peers of United (UAL) and American (AAL) during that same period of time.

They have been known to utilize some practices (tricks) unique to the industry to achieve operational outperformance. This includes purchasing its own oil refinery, acquiring used aircraft in lieu of spending significant capex for newer variants, and taking equity positions in many of its international partner airlines. These various strategies have some merits, but shareholders should be well aware of the impacts to overall returns when evaluating an investment in the airline.

The Fortress: Efficient Hubs With A Premium Product

If you look up the definition of Fortress Hub in the dictionary, it will probably have a picture of Atlanta’s Hartsfield-Jackson International Airport next to it. Delta controls over 80% of the passenger traffic at its largest hub along with its Sky Team alliance partners. The airports’ linear architecture with parallel runways offers an extremely efficient hub for connecting passengers and in geographical position in the Southeast funnels passengers from the Northeast, mid-Atlantic, and Florida to the rest of the U.S.

Similar hubs are operated in Detroit and Salt Lake City with trans-Atlantic traffic capitalized on via operations in New York and Boston. If it has a hole in its network it is in Texas as I opined in my article on Alaska Airlines. It has also experienced mixed returns in its efforts to expand Seattle as a domestic hub and international gateway.

Delta focuses on offering a more premium product and values significant business from business travelers. They are slowly transitioning to a focus on premium leisure travelers as they adjust to demand changes coming out of the pandemic.

The headline for us is that premium leisure, we believe, is here to stay. And that’s something that we want to continue to exploit as we think about we service our customers moving forward and how we lay out the plans and what products and services we offer.

Glen Hauenstein, President – 4Q2021 Earnings Call

They have recently introduced a new cabin product, “Delta Premium Select,” and will have a total of (5) different cabin products to choose from on all trans-Atlantic flights by 2023. All of these changes are targeted at premium leisure customers and business travelers that are restricted by their travel policy to purchase lie-flat seats at the highest price point offering.

The Fleet: Transformation Is Just Beginning

Delta has a long history with stretching the useful life of aircraft in their fleet and taking in older aircraft second hand to limit capex expenditures related to new aircraft purchases. There is a slow transformation in place towards a more consolidated fleet, but the company still has multiple aircraft types in service that are beyond 20+ years in age. In fact, 8 out of the 16 aircraft types are beyond an average age of 20 years. The MD-80, MD-90, and Boeing 777 fleets exited during the pandemic, but we haven’t seen the acceleration of aircraft retirements like we saw with many of the other airlines.

It can be expected that in the next 5 years Delta will be looking to retire most, if not all, of the Boeing 717, Boeing 737-800, Boeing 757-200/300, Boeing 767-300ER, Airbus A319, and Airbus A320 fleets. That represents exactly 400 of the ~800 airplanes currently in service. Subsequently, the company entered 2022 with a total of 288 aircraft on order that are scheduled to be delivered from 2022-2027.

The preference seems to be on a continuance of up-gauging the fleet since they do not have enough Airbus A220 orders to replace the entirety of their short-haul narrow body fleet. A majority of the additions will come in the form of a handful of (29) used Boeing 737-900ERs and (155) firm orders for the Airbus A321neo, the largest of the Airbus A320 family.

This is ultimately going to lead to higher capex expenditures in the coming years with the airline entering a period of new aircraft adoption.

The Balance Sheet

Full Year 2021 Results
Cash & Cash Equivalents	$7,933M
Debt & Finance Leases	$25,138M
Total Operating Revenue	$29,899M
Total Operating Expenses	$28,013
Operating Income	$1,886M
Net Income	$280M
RASM (cents)	13.71
CASM (cents)	12.12

Source: Delta 4Q2021 Earnings Results

Delta noted that debt will be increasing slightly in 1Q2022 due to expected loss and one-time maturities in the quarter, but will return to paying down the debt for the remainder of the year. The stated goal is return to net debt of $15 billion by 2024. The total debt will continue to weigh on shareholder returns in the coming years and it is anticipated that there will not be share repurchases or a reinstated dividend until they hit their debt target.

The narrow net gain for 2021 was a positive and the company, like most of the industry, is expecting to return to profitability from Q2 on.

Costs are up relative to 2019, but Delta provided the below chart to illustrate that they anticipate their CASM to slowly revert back towards 2019 levels over the next three years.

RASM & CASM

The true upside is in revenue improvement for Delta as demand for travel returns in 2022. Delta had produced a RASM of 17.07¢ in 2019. If it can return to those type of levels by 2023 then the spread with CASM could produce significant profits for the company.

More importantly, it will ultimately be the metric to determine if the overall strategy of focusing on its premium product and long-haul international flying is paying off.

Long-term, our opportunity is international. And when you think about growth, when you think about expansion, when you think about the natural opportunities that Delta has for the future, it’s going to sit in the international arena.

Glen Hauenstein, President – 4Q2021 Earnings Call

International travel traditionally has higher margins and can help to boost RASM, but there are concerns that international travel may continue to be strained in 2022. Most of Delta’s international revenue comes from trans-Atlantic routes and may come under pressure more than previously anticipated in 2022 due to the conflict in Eastern Europe. They have plans to return and/or add routes to Europe in 2022, primarily from New York, but revenue may lag original estimates.

Delta trails United and American in the Pacific, where demand is still very shallow, and they recently made significant cuts to Tokyo and Seoul in 2022. They also do not have a Latin America gateway to the level of Miami or Houston where premium leisure travel seems to be returning in strength.

The Macro Ratings

I touched on the 5 macro trends one should consider when evaluating a play in the overall industry in my introduction to this series. You can read my full article here.

1. The Price of Oil – (Neutral) The recent rise in the price of oil will weigh on the airlines in 2022 and expectations are that prices will remain elevated given geopolitical tensions and the demand for travel returning. The oil refinery business stands to benefit and could offer a boost to revenue unique to Delta.
2. Demand for Travel – (+1) Spring & Summer bookings are anticipated to be as good or better than 2019 as the industry transitions to a post-pandemic era. Delta has more exposure to trans-Atlantic travel which may suffer in 2022 due to the conflict in Eastern Europe.
3. Profitability – (+1) January & February will be unprofitable with March expected to be a return to profitability. CASM will remain inflated in 2022 and the premium international and business traveler may not return as quickly as Delta hopes. However, they were able to squeeze out a narrow profit in 2021 which is a positive setup for 2022.
4. Capital Flows – (-1) Delta is in a period of significant transformation to their fleet and will be adding new plans at a steady rate. Capex spend is anticipated to be elevated to their peers.
5. Consolidation – (Neutral) This gets bumped up to a positive if the merger of Spirit and Frontier is approved. They don’t compete for the same type of customer and consolidation has a history of leading to tailwinds for the overall industry.

Delta has an overall score of +1.

Investment Thesis

I currently maintain a Hold rating on DAL. The company has a good, but not great, balance sheet and paying down the debt load will be a priority for the coming years. Delta will most likely be the most profitable of the Big 3 legacy carriers in 2022 and will go toe-to-toe with Southwest (LUV) in most performance metrics.

I believe investors should take pause when considering Delta’s overall strategy. They were very straight forward on their 4Q2021 earnings call that they believe the biggest opportunity for growth is with Long-haul International Travel. They offer one of the best products, if not the best, in the U.S., but it is still uncertain as to whether this specific type of travel will return enough in 2022 to really produce for the airline.

Their equity investments in their partner airlines may compound the issue if international travel does not return and analysts recently questioned the strategy on the earnings call. I would have preferred to see that $1.2 billion go towards reaching their debt target at a faster pace.

If there is one thing we know about Delta, it’s that they will ultimately execute their strategy at a high level. I am just taking a wait and see approach in 2022 to see how business and international traffic responds.