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Morningstar | Delta Catches Jet Stream with Loyalty Program Extension; We're Maintaining our FVE. See Updated Analyst Note from 10 Apr 2019

On solid first-quarter results, no-moat Delta Airlines beat consensus and its shares carried their momentum from last week's loyalty program announcement. We remain impressed with the details surrounding Delta’s credit card program renewal, but we’re maintaining our fair value estimate on softness in several core flying markets. The new frequent flyer program agreement raised unit revenue or adjusted TRASM growth by 1 percentage point to 2.4%, helping the carrier beat consensus and outpace its earlier guidance. The carrier also benefited from slightly lower non-fuel unit costs or CASM-ex, thanks to higher than expected capacity growth (5%) and mostly single-digit inflation from remaining operating expenses. Tamed oil prices helped Delta expand adjusted pretax margins 100 basis points versus the March quarter in 2018. Corporate demand remains firm and management believes booking curves reflect firm demand; however, flat to down yields and sliding load factors in several markets indicate demand and unit revenue is beginning to taper and normalize. As such, we’re leaving our fair value estimate unchanged.

Unlike comparable airlines, Delta put together solid operational performance during the quarter, uninterrupted by cancellations and MAX groundings. Strong completion factors helped add 1 percentage point of capacity growth during the first quarter while roughly 6% growth in domestic and Atlantic markets drove total seat mile growth to 5%. Delta’s robust supply growth this quarter helped drive unit costs lower, but also had some effect on unit revenue. Diverging from previous quarters, unit revenue growth year over year in domestic, Atlantic, and Pacific markets were about 1% higher and down 2.6% and 2.8%, respectively. Despite management’s positive tone, we believe growing competition in Atlantic markets and Brexit risks represent legitimate headwinds and will help drive yields and passenger demand lower over the next two years.

We made several changes to our model following management’s second-quarter guidance and status update on current initiatives. First, we raised ASM (available seat mile) growth after Delta recorded mid-single-digit growth in the first quarter but also rolled out plans for almost 4% growth in the coming quarter. Combined with second-quarter guidance, our previous estimates would have placed capacity growth in the back half of 2019 below 2.5%, year over year. We think Delta is more likely to keep its growth pace due to fleet transformations that will inject larger aircraft into several markets and perceived booking curve strength leading into summer months. Our updated model reflects second-half capacity growth of 3% with full-year growth over 4%, about 60 basis points above our previous forecast.

We still model load factor degradation longer term, after examining monthly traffic statistics through the month of March and first-quarter results. Demand in markets like the domestic U.S. remains lofted, above 5%, and load factors remain tight but we’re maintaining our expectations for normalized growth as U.S. economic growth begins to slow. In other markets, like the Trans-Atlantic, we see a confluence of factors impacting the network’s overall performance. New widebody capacity by North American carriers and potential price competitive capacity from JetBlue could pressure load factors and subsequently stem Delta’s planned unit revenue gains. We also believe potential turmoil in European markets could serve to weaken passenger demand over the coming years. That said, the exit of WOW Air capacity could momentarily support passenger yields and management believes a shift to U.S. point of sale entering summer months could serve as a tailwind.

Our adjusted TRASM growth, excluding refinery sales, for full-year 2019 is about 30 basis points higher after incorporating updated assumptions mostly for Delta’s MRO business and renewed loyalty program. We raised our assumptions after Delta’s updated agreement added 1 percentage point to growth in the first quarter, but also management revealed guidance for year-over-year adjusted TRASM growth between 1.5% and 3.5%, for the second quarter. Our 2% adjusted TRASM growth is based on second quarter growth at management’s midpoint in the second quarter and 2% average growth in the back half of the year. Together, our assumptions place full-year 2019 adjusted TRASM growth at around 2%, below Delta’s 4.3% last year. Over the life of the new American Express agreement, we see a little more than $3 billion in value add versus the previous deal. Delta's plan to reach $7 billion in American Express contributions through 2023 compares favorably to its previous target of $4 billion in 2021.