Delta, United See Glimmers of Hope Despite the Red Ink

Madhu Unnikrishnan
October 18th, 2020 at 7:44 PM EDT

  • There’s no pretending that Delta’s third quarter was anything but cataclysmic. From July to September, typically the best quarter of the year for U.S. airlines, Delta spilled $5.4b in red ink. All right, so this was only $2.1b when stripping out special items. But a $2b-plus net loss is woeful enough. Operating margin excluding items was negative 89% as revenues dropped 79% y/y on 63% fewer seat miles flown. Operating costs, a good chunk of them fixed regardless of what happens to capacity or revenue, declined only 52%.

    When the Covid crisis began in March, airlines didn’t expect things to be this bad seven months later. It’s why they lobbied for federal aid to get them through Oct. 1 — conditions would surely be better if not great by then, they supposed. In some ways, to be sure, they are better. Through the first 14 days of October, TSA checkpoint traffic at U.S. airports was down 65% y/y, not 95% like they were through the first two weeks of April.

    Delta, now flying more than 1m people a week, has had zero documented cases of Covid transmission aboard any of its aircraft. Anecdotal evidence suggests more and more Americans recognize this, losing their fear of flying (as often happens pretty quickly after accidents, crashes, acts of terror, etc.). More would surely be taking to the skies right now were it not for quarantine rules, not just imposed by other countries but also by individual states like New York and New Jersey — fly to Florida from LaGuardia or Newark, for example, and you must self-quarantine for two weeks upon return.

    Still, as Delta’s president Glen Hauenstein put it, “we’re closer to the end of the pandemic than we are to the beginning.” The airline, he adds, has seen “steady progression in demand” since July. That’s helped to reduce average daily cash burn to $18m in September. Delta produced just a tenth of its normal revenues in Q2. That rose to a fifth in Q3. And the expectation is to reach about a third in Q4. Here again: evidence of meaningful if modest progress. The critical corporate segment — think companies like Coca-Cola globetrotting around the world in business class — remains deeply depressed — corporate revenues were just 15% of their normal levels last quarter. But they’re trending up across all industries, and some 90% of the carrier’s major corporate accounts have at least some of their employees flying again.

    Geographically, coastal business centers like New York, Boston, and Seattle, with their large components of corporate travel and international travel — and in some cases their home state’s quarantine rules — are seeing the biggest y/y traffic declines. On the other hand, mid-continent hubs like Atlanta, Salt Lake City, and Minneapolis are more important than ever for funneling traffic around the country at a time when many nonstop routings are disappearing. Ditto by the way, for international hubs where its joint venture partners reside, i.e. Paris, Amsterdam, London, and Seoul. Domestic leisure markets like Florida and other beach destinations, and Salt Lake City and other mountain destinations, are out-punching their weight in terms of nonstop demand. Internationally, Caribbean and Mexican beach destinations are likewise showing signs of life (Mexico has no quarantine restrictions for visiting Americans; see feature story below).

    Delta, keep in mind, is still blocking middle seats and capping load factors, unlike its rivals American and United. When it decides to lift these self-imposed restrictions sometime in the first half of next year, revenues will get a sudden boost. Already boosting revenues — or least softening their decline — are non-ticket sources like cargo and SkyMiles. Americans are still eagerly spending money on their Delta-branded American Express cards, anticipating a return to travel soon enough. Card spending on Delta tickets specifically, sure enough, is rising as well.

    There are other positives: extremely low fuel prices, for one, record-high customer satisfaction scores, new airport facilities (i.e. in Salt Lake City), lower construction costs for new facilities, a streamlined fleet, and early signs of efficiency gains from efforts to remove costs. Delta is 20% smaller than it was at the start of 2020, in terms of capacity and workforce. But it happily won’t have to furlough any non-pilot employees, almost all of whom are not part of a union (non-pilot labor costs have dropped by more than 40% since the start of the crisis). Unionized pilots, on the other hand, do face furloughs on Nov. 1, but negotiations are underway to potentially avoid that.

    As Delta looks ahead, it sees at least two more years of abnormally low revenues. The return of corporate demand might take a bit longer, but return it will, CEO Ed Bastian insists. “Every crisis that I’ve been part of… [people said] technology was going to replace the need for travel. And every single time, business travel has come back stronger than anyone anticipated.” Don’t forget that Delta is still in the process of building a new joint venture with Latam, not to mention WestJet, pending DOT consent. Another big opportunity is in maintenance, with valuable rights to service next-generation Rolls-Royce and Pratt & Whitney engines.

    With a gargantuan $22b of liquidity, Delta has all the cash it needs to outlast the crisis and eventually start repaying all its new debt when cash flow once again turns positive (it hopes to get there by spring). Restoring its investment grade credit rating is a top priority. So is taking out older planes, with nearly 30% of the entire fleet expected to leave by 2025. That’s some 400 airplanes — B777s, B767s, B717s, CRJ-200s… all on the way out. Delta revised its Airbus order book as well, slowing deliveries of A350s and A330 NEOs to save more than $5b through 2022 (it also has A321 NEOs and A220s on order).

    The next near-term milestone is the upcoming Thanksgiving and Christmas holidays, which are currently generating some “good booking momentum.” It’s adding more capacity on peak travel weeks, while trimming during slower weeks around Halloween and the presidential election. Delta remember, followed United’s lead in permanently eliminating domestic change fees for all but its basic economy tickets. Internationally, it hopes Covid testing can become an important catalyst of demand revival.
  • United’s Q3 operating loss margin was a bit worse than Delta’s: Negative 108%. Net loss excluding items was $2.4b. The Chicago-based airline, however, thinks it’s best positioned among the Big Three to recover, claiming the lowest current cash burn and predicting it will be the first to turn cash flow positive. Its Q3 revenue trends were a bit better than Delta’s, with revenue falling a similar amount y/y (78% compared to 79%) but on less capacity (ASMs were down 70% compared to Delta’s 63% drop). United is getting help from having the largest cargo business of any U.S. airline, operating more than 3k cargo-only flights last quarter and doubling its cargo revenues to more than $400m. It used its valuable Mileage Plus loyalty plan, meanwhile, as collateral for novel financing arrangements that raised almost $7b in cash — Delta and Spirit followed with loyalty plan-backed private sector borrowing of their own.

    United, unlike Delta and Spirit, also opted for government financing made available through the Federal CARES Act. So like all U.S. airlines, liquidity is not a concern for United. Nor, anymore, is mere survival. Instead, the focus is on positioning the airline to best take advantage of the coming recovery, whenever it comes. As CEO Scott Kirby has said repeatedly, demand won’t return to more than half of what it was pre-crisis until mass vaccination. But like Delta, United is indeed seeing modest demand improvement this fall, thanks to growing confidence and comfort about the safety of flying. It hopes to further bolster that confidence with on-site and pre-departure Covid testing for passengers, ensuring no one aboard is infected. A trial is underway on San Francisco-Hawaii routes, with hopes for widespread industry adoption across the world by spring.

    One reason United expects a more robust recovery relative to its peers: Its outsized presence in global business centers like New York, Chicago, San Francisco, and Houston. They’re disproportionately hurt by the crisis but by extension, disproportionately poised to benefit when companies resume their travel and international markets reopen. For now, United’s Denver hub is a diamond in the rough, both for its tourist appeal and its geographic location as a connecting hub for many itineraries no longer available nonstop. Of course, Denver is hyper-competitive with Southwest and Frontier also boasting big operations. Southwest, come the mention it, just said it will start flying from United’s O’Hare and Bush hubs in Chicago and Houston, respectively (see Routes section below).

    United, while naturally shrinking, is itself adding new markets, and not just Florida routes. Internationally, it’s launching five exotic new routes to Africa and India, some late enough in 2021 to perhaps coincide with a vaccine rollout. United calls one of the new markets, San Francisco-Bangalore, among the most anticipated new route launches ever. Just last week, it announced another round of new sunshine routes to beach spots in Mexico and Central America (see Routes section below). Overall for this month, total capacity is about 40% of normal levels, this after scaling back capacity restoration during mid-summer amid what was then a stalled demand recovery. Q1 will likely be at similar levels to Q4. Remember: Ramping up capacity is key to depressing non-fuel unit costs but doesn’t make sense until demand can support it.

    Today, Covid cases are spiking again nationwide, but death rates are down, treatments are improving, and, as mentioned, people are becoming more relaxed about air travel regardless. Naturally, desire to travel is bursting at the seams for many Americans stuck at home for the past half-year. Companies too, United believes, will be eager to hit the road again when offices reopen, and sales reps inevitably realize that selling via video just doesn’t replicate the effectiveness of selling in person.

    Until then, Kirby and his team are slashing costs, which unfortunately means furloughing 13k employees. Not pilots though. United and ALPA reach a no-furlough deal that also includes additional limits on the airline’s ability to outsource regional flying. For other work groups, there’s still some glimmer of hope that Congress might extend payroll relief that expired on Oct. 1. If not, a new Democratic regime in Washington, if elected, would likely pass something in early 2021. A key priority with respect to labor costs, as well as costs in other areas, is moving them from fixed to variable as much as possible. Delta’s high percentage of variable costs, incidentally — enabled in part by a flexible mostly non-union workforce — was a key driver of its pre-crisis margin success.

    As for fleet, United is not, unlike Delta and American, mass retiring older airplanes. Instead, it’s keeping idled planes around for use if needed when demand returns. It also emphasizes a recent shift from focusing exclusively on preserving cash to a restoration of some investment spending, including the resumption of retrofitting widebodies with its latest Polaris product. It also intends to reenter New York JFK airport in deference to the needs of key corporate customers in markets like California. It led the way in abolishing change fees while relaxing standby policies. Its cargo team is preparing to help ship vaccines when ready.

    Kirby makes no secret of his expectation that the next year or so will be tough. We’re only at the end of the beginning, not the beginning of the end, he asserts, channeling his inner Winston Churchill. But — it’s an important but — the other side of the crisis will see a radically altered competitive landscape, especially on overseas routes where battered rivals are mass retiring giant jumbos like A380s and B747s. 
Madhu Unnikrishnan
October 18th, 2020 at 7:44 PM EDT

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