Delta's [Premium] Air Lines
- nhryanhickey
- Jul 11
- 5 min read
♪Come fly with me let's fly, let's fly away♪ - Frank Sinatra
Earnings season is upon us.
Gear up because next week will be filled with a deluge of earnings reports. Over 140 companies are expected to report next week.
But First a Tangent…
An important, although fairly obvious point to make is that earnings calls are not ‘audited’ or ‘reviewed’ by external auditors. Only annual reports are audited. Quarterly reports are only reviewed. And in my experience, very few auditors, if any, even listen to the earnings calls. And because they are not audited or reviewed, they can act as a litmus test.
Do the comments on the call align with the numbers presented in the reports? How does the management team sound? What is the tenor of the call?
Prepared remarks can be useful. But they are choreographed to be well-received by investors. The real value comes during the Q&A. Analysts have the opportunity to ask challenging questions to management, who are not necessarily ready with a curated response.
Delta's [Premium] Air Lines
Delta Air Lines reported on Friday. And they had some interesting commentary. One of the early prepared remarks from the CEO discussed the consumer.
“Turning to the current environment. The U.S. economy remains resilient, supported by strong employment, rising household incomes and strong significant wealth accumulation. Our customers are prioritizing experiences and investing in the moments and connections that matter most to them, driving sustained strength and demand for air travel. These trends align well with Delta's strategy, demonstrating the loyalty that we are seeing across customer segments and powering high-margin diverse revenue streams that enhance the resilience of our business.”
And that is true. Delta’s customer base was healthy this quarter. But...that is because Delta has continued to strategically focus on higher-income demographics. CEO, Ed Bastian, confirmed as much during an interview with the Financial Times.
“Our consumer, which is a more premium consumer, is really healthy financially,” chief executive Ed Bastian told the FT. “The wealth accumulation that they’ve experienced over the last number of years post Covid is meaningful.”
It was noteworthy that the CEO decided to focus only on the premium consumer. Later in the earnings call, Delta management addressed the industry as a whole and they appeared much less optimistic about the non-premium consumer and the macroeconomic backdrop.
“The--what we've seen and it's not just this quarter, it's been building for the last several years is that we've seen some fairly significant structural changes to the overall industry landscape. Probably the last time that we saw the element of fuel moving around with a lot of volatility was maybe 9, 10 years ago. And back then, the low-cost carriers were the darlings of the industry. They had the highest margins. They had the highest growth rates. They looked fuel as a competitive advantage because they had lower cost in other areas. Some of them such as Southwest had fuel hedges in place, which they used to try to take market share. None of that exists any longer. All of that world has changed completely -- entirely. No one has fuel hedges of any note. The cost of production, not just for fuel is up, but the cost for labor is up, the cost for airports are up, the cost for technology is up. Planes, you can get. And if you can get them, their costs are higher…The fact that you've got others in the industry following our lead is no surprise as well. But I mentioned a point on the call this morning, that even with the improvements we've seen in pricing for the industry, the low end of the market still has to increase fares by another 5% by our estimate, just to get to breakeven at today's fuel environment. And there's nothing to be gained by trying to grow in that environment. The opportunity has to be in finding ways to secure higher revenues, not higher market share.”
The sentence in the previous quote is quite striking, 'there’s nothing to be gained trying to grow in that [low end] market.’ It seems that the average consumer can no longer afford to absorb even the +5% fare increase necessary for airlines to maintain their current margins. Inflation has become a serious headwind to the US economy. It does not appear to have let up since the prior quarter. And so, the airline industry justifiably has repositioned itself to target higher income demographics, who can afford to pay higher fares. From the press release:
“June quarter total revenue increased 14 percent over the same period last year to a record $17.7 billion on approximately 1 percent capacity growth. Adjusted total unit revenue (TRASM) grew 12.4 percent over prior year. Main cabin unit revenue grew double-digits, marking the second consecutive quarter of positive main cabin growth. Domestic unit revenue grew 12 percent year-over-year and international unit revenue increased 8 percent, led by Latin.”
The issue with this strategy, is that inevitably, you can only raise prices so much before even the less price sensitive customers pull back on flying. But for now, Delta is catering to those who can absorb price inflation, because the low-cost carrier model is becoming an unprofitable model. And their revenues are benefitting from these price increase, although their margins being compressed. Delta discussed the challenging environment for low-cost carrier models during their call:
“Well, actually, in the second quarter, our unit revenue in main cabin did exceed premium because we are down in capacity. And the industry has removed significant amount of unprofitable capacity. If you look at the ultra LCC category, that capacity is down about 30%. So main cabin has gotten significantly healthier this year. I mean, last year, it was one of our biggest objectives to improve the main cabin.
And also, we're not growing main cabin seats. This is a multiyear several years in a row that we haven't grown this cabin. We won't be growing it next year either. But our premium revenue has been up 17% and unit revenue is below main cabin, but our growth in that category has been up high single digits, while revenue is outstripping the capacity in premium revenue. So I think we're getting into a really good balance between main cabin and our premium cabins.”
These business decisions are illustrative of the environment that Delta's management is seeing in the economy. In my opinion, these decisions are more compelling than the numbers that were reported. Numbers change every week, month, quarter and year. Strategic decisions are the drivers of future earnings. They have long term effects and are costly to implement.
Delta’s premium customers may be healthy. I guess for now we will just ignore everyone else. But taking a step back, this seems to align with the K-shaped economy narrative. This could be an interesting reporting period.
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