Pushing Back: Inside This Issue
Three. Two. One… And we’re underway. Fourth-quarter earnings season is here, kicked off with another fine performance by Delta. More U.S. carriers report this week, including the three with major MAX exposure (Southwest, American, and United). Also reporting this week:
JetBlue, which last week announced a big network shakeup.
Don’t expect any shakeups at Qatar Airways, never mind the huge sums of money it’s losing. Instead, it’s expanding again, announcing eight new destinations. Back in the U.S., Allegiant announced a big expansion. The Brazilian airline Azul, which is buying a domestic regional carrier, is headed to New York. Delta is making moves on Miami, an American stronghold. American is making moves on Boston, a Delta stronghold. In Asia, Singapore Airlines and ANA appear poised to get closer, with Virgin Australia in the mix.
For three airlines, Cathay Pacific, South African Airways, and Flybe,
distress was the word of the week. Hong Kong’s traffic remains depressed.
SAA is hanging by a string. And Flybe became a recipient of
“Securing a tentative agreement this year is the pilot group’s most important task. We’re working to regain years of lost ground.”United Pilots Union Chairman Todd Insler
Net result in USD; operating margin
October-December (3 months)
- Delta: $1.1b; 12%
April 18-March 19 (12 months)
- Qatar Airways: -$640m; -12%
*Net profit excluding special items (all operating figures exclude special items)
- Could business conditions possibly be any better? For Delta right now, a strong economy means demand conditions are excellent. Missing B737-MAXs mean supply conditions are constrained. And arguably most helpful of all, fuel prices are down significantly, dropping below the $2 per gallon mark last quarter. Delta thus coasted to a 12% operating margin from October to December, its best Q4 performance since the big fuel bust of 2015. Total Q4 fuel costs, stunningly, plummeted 16% y/y, even as the airline expanded ASM flying by 5%. Efficient new planes like A330 NEOs and A220s certainly helped. Total revenues rose 7% while total costs rose just 3%, allowing Delta to easily beat its Q4 2018 operating margin of 10%.
Results were no less impressive for the entirety of 2019. Full-year operating margin was 14%, up from 12% in 2018. The last time this airline lost money was 10 years ago, during the depths of a global financial crisis and a period of merger integration with Northwest. Boy, have things progressed since then. If there’s one mildly unflattering thing to say about Delta right now, it’s that non-fuel unit costs (up 4% last quarter), are rising faster than unit revenues (up 2%). Attribute that to heavy spending on product improvements, along with elevated increases in labor costs (up 8% last quarter). Labor costs could take another jump when Delta ultimately comes to terms on a new contract with its unionized pilots (all of its other major work groups are non-union, an important competitive advantage).
The two sides have some areas of contention, including pilot displeasure with what the union sees as outsourced flying to lower-cost joint venture partners like Virgin Atlantic and Aeromexico. One additional fact about employee relations at Delta: 2019 was its sixth straight year of sharing more than $1b in profits with staff. In any case, Delta’s cost situation is hardly alarming, especially given that non-fuel CASM for all of 2019 did not grow faster than unit revenues, rising in line with long-term goals. Looking for other relatively trivial areas of concern? Well, cargo revenues dropped by double digits. Weakness on China and Korea routes are weighing on the performance of Delta’s Asian network, which is otherwise benefitting from improved health in Japan and the success of Premium Select class.
On transatlantic routes, weak foreign currencies like the euro and pound created some drag (though they strengthened a bit versus the dollar in Q4). In Latin America, unit revenues rose sharply, especially in Brazil and Mexico as capacity receded. Mexican routes were impacted by Aeromexico’s missing MAXs. In Europe, meanwhile, executives spoke of “green shoots” as currencies stabilize. And then there’s the U.S. domestic market, which Delta recently said accounts for about 80% of its total profits now. Here, everything was good: Corporate, leisure, premium, economy… strength was particularly evident on peak travel days during holiday periods. It also helped that this year’s calendar had a shorter offpeak window between Thanksgiving and Christmas.
Geographically too, strength was widespread, with revenue and margin gains at every domestic hub. RASM was up 10% at coastal hubs (New York, Seattle, Los Angeles, and Boston) and 6% in core interior hubs (Detroit, Minneapolis, Salt Lake City, and of course Atlanta). With respect to corporate demand, even the manufacturing sector shows signs of vitality despite tariff difficulties (Its Detroit hub is notably dependent on travel demand by auto manufacturers). Favorable supply and demand conditions continue to prevail in the early days of 2020, and current estimates foresee pretax margin for the January-to-March quarter somwehre around last year’s 8% mark. Looking farther ahead, Delta sees revenue gains from many directions.
There’s its ultra-lucrative deal with American Express of course, with a new portfolio of credit card offerings debuting this month. The partnership is based on the extraordinary value travelers feel they’re getting from Delta SkyMiles. There’s its collection of joint ventures, many of them equity based. Alitalia appears to be out of the picture now. Gol is gone. But Air France/KLM and Virgin Atlantic are combining their Atlantic ventures with Delta, complementing JVs with Virgin Australia, Korean Air, and Aeromexico. China Eastern is a key partner. A WestJet JV awaits DOT approval. And yes, Latam is now a partner, following Delta’s sensational coup to grab it from the clutches of American. Codesharing should commence later this quarter. Another source of future revenue growth is the premiums travelers are increasingly willing to pay for Delta’s superior reliability and service.
Big investments in airport development, inflight products, operations, brand awareness, and information technology, it thinks, should further enhances its pricing power and RASM premiums. More new planes are coming, and perhaps before long an order for A321 XLRs if Boeing proves unwilling to build the NMA jet Delta badly wants. Delta might want to buy some B787s as well. New routes on offer include Amsterdam-Tampa, Boston-Edinburgh, Boston-Lisbon, Boston-London Gatwick, Minneapolis-Mexico City, Minneapolis-Seoul, New York JFK-Bogota, Seattle-Osaka, and New York JFK-Mumbai, the latter generating revenues ahead of forecast, it says. Delta last month announced a partnership with Wheels Up, creating what it calls one of the world’s largest owned and managed fleets of private aircraft.
In Asia, having downsized from B747s to A350s and diverted connecting traffic from Tokyo to Seoul, the airline is now consolidating all of its Tokyo operations at Haneda airport and moving to the new Beijing Daxing airport, where partner China Eastern is building a hub. As it happens, capacity in the U.S.-China market is now declining for the first time in a long time. Maintenance revenues from third parties are already soaring, up 31% last quarter and destined for a further spike when Delta becomes a key servicing provider for new Rolls-Royce and Pratt & Whitney engines. Add to this a small but promising cabin interiors business. At this year’s consumer electronics show in Las Vegas, Delta showcased new technologies and a commitment to further invest in making journeys easier for its customers. Currently, 52% of the journeys it sells are booked directly through its own sales channels, where it has greater ability to analyze and influence customer behavior. That said, it’s using IATA NDC principles to improve merchandising capabilities via travel agents as well, here too with upselling in mind.
By upselling, Delta is referring to its “Next Best Offer” strategy, best explained with examples provided during the airline’s investor day event last month: “If you bought Main Cabin on your last 10 flights, we’re talking to you about buying up to Comfort+. If you bought Comfort+ on your last 10 flights, we’re talking to you about domestic first class…” And so on. This strategy helps to fill premium seats, justifying larger planes with larger premium cabins. Currently, 70% of Delta’s passengers that use a premium product wind up buying a product of equal or higher value during future travel. The carrier is also making it easier to purchase these upgrades with SkyMiles, and to do so via mobile channels like its phone apps. Digital investments like these, it estimates, along with product investments, generated about $200m worth of incremental revenue in 2019. More refined passenger segmentation, meanwhile, blurs the line between what was previously a binary split between extremely high paying premium fliers and much lower-yielding coach fliers.
This blurring, Delta believes, will make premium demand more resilient in any future recession. Perhaps, but 2020 will likely see some demand volatility around the presidential election this fall. In addition, industry capacity will jump when MAXs return. The Haneda and Daxing airport switches will incur short-term costs. So will switching its Latin loyalties from Gol to Latam, not to mention A321 NEO delivery delays. As for network priorities, Delta is adding some Miami service to boost its connectivity with Latam (see Routes section). It’s building business in high-growth cities like Austin, Raleigh-Durham, Nashville, and San Jose. It’s challenging JetBlue in Boston. And after spending lots of resources building up coastal hubs like Seattle, it will turn more attention to growing interior hubs. Executives aim for revenue growth of about 4% to 6% this year, propelled in summary by four engines: 1) strengthening brand preference, 2) better selling and servicing of products, 3) continuing to win with business and corporate travelers, and 4) driving increased loyalty with more customers.
- Qatar Airways continues to add routes to its global network, announcing another eight cities last week (see Routes section). But it continues to lose gargantuan sums of money, without any risk of bankruptcy or even pressure to cut costs. That’s because Qatar’s royal government willingly recycles proceeds from its energy exports into the airline, with the intention of developing the economy, adding high-skilled jobs, and gaining influence in capitals like Washington, Berlin, and Paris, where its heavy spending on Boeing and Airbus aircraft doesn’t go unnoticed. While no sane person thinks it smart for a country like India to funnel scarce taxpayer funds into a decrepit airline like Air India, the wisdom of Qatar’s support for its national airline is more debatable. With a tiny Qatari population that’s already rich, what else to do with all that oil and gas money? So how much money, exactly, is Qatar Airways losing? Its accounts for the 12 months to March 2019, released last week, show a $640m net loss.
They also show a negative 4% operating margin, though this figure excludes “general and administrative expenses,” a category in which the company lumps a large chunk of its labor costs. Exactly which labor costs? It doesn’t say. But include this category and operating margin was really negative 12% (compared to negative 9% a year earlier, by the same measure). During the fiscal year, Qatar’s revenue grew 14% to $13.2b, which is similar to what Emirates generates annually, excluding Dnata and other affiliates. For Qatar, 71% of the $13.2b comes from passenger air service, another 21% from cargo, and 4% from duty-free sales (including its exclusive right to sell alcohol in the country). The rest comes from a long tail of auxiliary businesses like hotels, airport management, catering, and leisure travel. It sells trips on executive jets too, though it’s not specified whether that counts as passenger revenue. In any case, Qatar Airways is involved in all aspects of its country’s aviation sector. During the period, it grew ASK capacity 13%, maintaining expansion even after a mid-2017 blockade that evicted it from key Gulf markets like the UAE and Saudi Arabia. Its fleet continues to grow as well, topping the 200 mark, or 250 including cargo-only planes and executive jets. Another 300 planes remain on order, including options and purchase rights.
Among these are B777-9s, highlighting Qatar’s readiness to buy just about anything Boeing and Airbus puts in front of its eyes. It’s also buying A321 NEO LRs (though not yet XLRs). It currently operates A320s, A330s, A340s, A350s (both -900s and -1000s), A380s, B787s, and B777s. And yes, it has large numbers of MAXs on order too. It began life a little more than two decades ago with just four planes. The company admits to being disappointed about its heavy losses, which it attributes to a 36% jump in fuel costs and adverse foreign exchange trends. The Qatari currency is fixed to the U.S. dollar but much of the revenue it generates from ticket sales comes in currencies that have sharply weakened versus the dollar (i.e. euros, pounds, Australian dollars, etc.). The embargo, also inhibits Qatar from flying over Saudi airspace, which makes journeys to markets like the U.S. considerably longer and more fuel-intensive. For a time, the company expressed interest in launching a new Indian airline, or alternatively investing in IndiGo. Nothing of the sort has transpired.
But Qatar is a major if passive shareholder in IAG, Latam, Cathay Pacific, and China Southern. It also owns roughly half of Alitalia challenger Air Italy, where it’s more involved in management. Can the Doha market really support a global airline? No, as the airline’s prodigious losses show. The local market is simply too small, and the surrounding hub competition too great. Thanks to the convenience conferred by geography though, attracting people to connect through Doha isn’t hard, if prices are low enough. The country hopes the future will bring more visitors, creating a larger inbound local market. Central to its mission of achieving that goal: Hosting the 2022 football/soccer World Cup, an event the whole planet will be watching.◄