Earnings Preview: Delta Air Lines

Delta Air Lines Inc. (DAL), the second largest U.S. airline, is slated to release its first quarter 2011 earnings on April 18. The current Zacks Consensus Estimate for the first quarter is 46 cents, representing a substantial decline of 101.98% from the year-ago level.

Delta had negative surprises of 4.04% in the last four quarters of 2010. The first quarter of 2011 is also expected to be dampened by escalating fuel prices, lower capacity as well as the drop in air traffic resulting from the March 11 catastrophe in Japan.

Delta Air Lines has the largest presence in Japan relative to other U.S. carriers such as United Continental Holdings Inc. (UAL), AMR Corporation (AMR) and Southwest Airlines Co. (LUV). Notably, Delta generates almost $2 billion in revenue every year from planes flying the Tokyo hub. The massive earthquake and radiation leaks from, which took a toll on Japan’s economy, affected demand of air travel in that country.

In order to tide over the situation, Delta is cutting capacity by 15% to 20% through May to reflect falling short-term demand and suspending service to Haneda. In addition to the cut in Japan flights, Delta Air Lines is lessening departures at its Memphis hub by 25%. The reduction in capacity will hurt Delta’s revenue in the range of $250 million to $400 million in the first quarter.

Further, soaring fuel prices are expected to lift Delta’s fiscal 2011 fuel expenses by $3 billion or 35% over the last year. Delta expects operating margin of negative 2–3% for the first quarter, down from the expectation of positive 1–3% provided in the fourth quarter conference call.

Fourth Quarter Flashback

The share price of Delta Air Lines dropped the most amongst its peers since October 2009 following its fourth quarter earnings release.

In the fourth quarter of 2010, Delta’s adjusted earnings missed the Zacks Consensus Estimate by 6 cents. Soaring fuel prices as well as flights cancellations due to severe snowfall in December across the U.S. and Western Europe resulted in lower-than-expected results.

However, the company reported improved revenue during the last reported quarter owing to high traffic and increased capacity. Airline traffic, measured in billions of revenue passenger miles, was up 6% year over year. Capacity or available seat miles grew 7% and load factor (percentage of seats filled with passengers) inched down 60 basis points from the year-ago quarter.

Agreement of Analysts

Estimates for the first quarter have been trending downward over the last 30 days. 10 analysts out of 11 have made downward revisions while none analysts move in the opposite direction. Over the last seven days, one analyst reduced their estimates while none made positive revisions.

For fiscal 2011, out of 11 analysts, 9 revised their estimates downward over the last 30 days and 2 made a similar revision over the last 7 days. None of the analysts made any positive revision to the estimates over the last 7 days while one revised its estimate upward over the last 30 days.

The analysts are concerned about the profitability of the overall airlines industry. Last month, the International Air Transport Association (IATA) cut the overall airlines profit outlook for 2011 to $8.6 billion from its prior expectation of $9.1 billion.

Persistently rising fuel prices since last December have surfaced as a major headwind to the industry. Crude oil prices are currently trading around $110 per barrel, representing the steepest rise in more than 2 years. Oil prices have already risen more than 21% this year due to the ongoing political unrest in the Middle East. U.S. carriers are struggling hard to deal with increasing costs either by flying less or charging more.

Another risk to the airlines companies, which is currently persisting all over the world, is the aftermath of the Japan’s disaster. Following the massive earthquake and tsunami in Japan, air carriers are making drastic cuts in their capacities. People are scared to fly to Japan due to the still unsettled nuclear situation. The drop in demand for air travel to the country is hurting overall airline profitability.

Magnitude—Consensus Estimate Trend

The magnitude of the loss for the first quarter has been increased to 46 cents from 42 cents in the last 7 days and 20 cents in the last 30 days.

For fiscal 2011, the Zacks Consensus Estimate is $1.35, down from $1.51 over the last 7 days. The fiscal 2011 Zacks Consensus Estimate also dropped from $1.77 over the last 30 days. The Zacks Consensus Estimate for 2011 reflects a significant 21.05% loss year over year.

We believe Japan’s calamity as well as higher fuel price will stall the ongoing recovery of the U.S. airlines, eating away Delta’s revenue and profitability for the year.

Our Analysis

For the short term (1–3 months), Delta Air Lines maintains Sell rating with the Zacks # 4 Rank due to the ongoing situations in the airline industry.Further, unionized labor, debt loaded balance sheet and competitive threats make us cautious on the stock.

However, we believe Delta Air Lines will likely have everything back in control as conditions stabilize in Japan. In all probability, the capacity cuts are temporary, and should last only for the next two–three months. Also, the company is combating rising fuel prices with higher fares and extra fees.

Additionally, we believe the successful integration of the Northwest merger, investments and expansion in new products and services, competitive cost structure, and strengthening balance sheet will position Delta Air Lines to take advantage of the economic recovery. Hence, we are currently maintaining our long-term Neutral recommendation on the stock.

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