Delta Air Lines

Moat: 2/5

Understandability: 2/5

Balance Sheet Health: 2/5

Delta Air Lines is a major US passenger airline, providing scheduled air transportation for passengers and cargo across the globe. It is structured like most airline businesses, being a highly capital intensive business with a high cost-base and exposure to commodity prices.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Delta Air Lines’ business model revolves around offering a network of air travel routes. They operate a hub-and-spoke system, concentrating operations in several major hubs like Atlanta, Detroit, and New York, which are key to their business. Their core services include passenger and cargo transportation across the U.S., and international markets.

Industry Overview and Competitive Landscape

The airline industry is fiercely competitive, characterized by high operating costs, sensitivity to fuel prices, and intense rivalry between existing firms. Profit margins in this business tend to be thinner compared to other industries. Here is a breakdown:

  • Competition: Highly competitive environment with numerous airlines vying for market share, both domestically and internationally. The industry is also consolidating rapidly with large mergers and acquisitions happening all the time.
  • Fuel Prices: Major operating expense that can fluctuate significantly, leading to substantial swings in profitability. Airlines frequently hedge their fuel positions to minimize the potential cost impact.
  • Labor Costs: A significant component of expenses due to a high employee count, this gives them a relatively large base of expenses that are difficult to optimize, and difficult to scale.
  • Regulatory Landscape: Highly regulated, with government bodies influencing routes, pricing, and safety standards, which gives incumbents advantages.
  • Demand Fluctuations: Highly susceptible to changing economic environments, demand swings, and global situations, which can lead to sudden changes in revenues.

Delta Air Lines’ Unique Aspects

While the airline business in general faces several challenges, Delta has also differentiated itself by building a customer-centric business, making it a high quality operator in the airline industry.

  • Global Network: Delta has an extensive global route network, allowing the airline to provide many international and domestic connections, increasing the number of passengers they can carry.
  • Customer Loyalty Programs: They operate the Skymiles program, with high customer retention rates and consistent revenue from customer engagement.
  • Fleet Modernization: Delta has been continuously updating its fleet, including orders for new and more fuel-efficient aircraft, resulting in an improved customer experience and reduced operating costs in the long run.
  • Branded Products & Services: Delta has created a name for itself by providing a differentiated and somewhat higher priced service compared to their peers, as reflected in their net promoter scores and customer loyalty programs.

Financial Analysis

Here, we will mainly focus on the latest reports and results available, as they are more indicative of the business currently.

Here’s a breakdown of Delta’s financial standing:

  • Revenues: Delta generated $15.6B in revenue for the quarter ending September 30, 2024 which was up by 11% YOY, an exceptional performance showing a strong recovery in demand for their services. The increase was primarily from strong demand and an increase in average fare prices.
  • Profitability: The operating income of Delta came at $2.3B for the last quarter, with operating margins at around 14%, an impressive value given their high operating costs and exposure to volatile fuel costs. Their full-year operating profit came at $5.4B, a more moderate margin of around 8%. A great improvement compared to 2021 or 2022, but still not a level of profitability that is seen in other industries.
  • Net Income: They generated $1.1B in net income in Q3 2024.
  • Cash Flow: Delta generated $2.3B in operating cash flow for Q3 2024 and $5.7B of YTD. In general, the cash flow seems to have recovered well.
  • Debt: They have a long-term debt of $26B, which is concerning as interest payments are difficult for airlines to pay when revenues shrink or stay the same.
  • Capital Expenditures: Capital expenditure in the airline industry tends to be high, particularly due to constant need for new airplanes and modern infrastructure. Delta’s capital expenditures are no exception. In 2022, capital expenditure came at roughly 5.4B dollars, while in 2023 it came at 5.2B.
  • Cash Position: They have approximately $7B in cash.

The figures have been improving quarter to quarter which is a good sign, and with the rise in air travel volume and higher prices the company is doing very well.

However, there are a few things to be careful of such as the amount of debt that is still very high, they have a high capital expenditure structure and are highly dependent on outside factors like oil prices and regulation, which they have very little control over.

Moat Assessment

Based on the characteristics mentioned above, here is a detailed explanation of Delta’s competitive advantages and limitations.

Moat Rating: 2/5

  • Limited Moat: Delta has some competitive advantages, but they are not strong enough to give the company a wide moat rating.
    • Network Effect: Airlines that build a huge network may benefit from it, and that may help them provide better service with more destinations at relatively low prices. Airlines with bigger networks have the advantage of having greater control of market share and may be able to raise prices to an extent. Airlines such as Southwest and Delta are notable here, since they have significantly large route networks.
    • Brand Loyalty: Through programs like SkyMiles, Delta has built a loyal customer base, making them have a slight advantage over other airlines. However, the low switching costs inherent in this industry make this advantage less significant.
    • Switching Costs: This is where airlines typically fall flat. The airline industry does not have particularly high switching costs. It is relatively easy for customers to choose different airlines based on price or other factors. Therefore, they don’t have much in the way of a moat created from switching costs.
  • Lack of Moat: However, several factors limit Delta’s moat:
    • Lack of Pricing Power: In the airline industry, firms are generally unable to maintain prices against competition. The product is not differentiated greatly, or they provide very similar services. As such, airlines can’t charge high prices, which can hurt their profits.
    • Commodity Nature: The basic service of air transportation is mostly a commodity, where customers are mainly concerned about price. There is little differentiation between services provided by different companies except price and location convenience, leading to little differentiation between airlines.
    • Low Switching Costs: Customers have low switching costs, which makes it easy for them to leave if a competitor offers better service or lower prices, this reduces pricing power.
    • High Operating Costs: Airlines are exposed to variable costs like fuel prices which are outside of their control. These volatile expenses can reduce profit margins quickly and lead to reduced or volatile profitability.
    • High Capital Requirements: Airlines require enormous investment in planes and maintenance, limiting the potential return on invested capital.
    • Regulatory Challenges: Government policies on routes, pricing, and safety standards lead to a challenging regulatory environment, that can affect long-term profitability, and give some firms unfair advantages.

Risks to the Moat

While Delta is an established carrier, it does face some problems that can potentially disrupt the business in a big way.

  • Fuel Price Volatility: Unpredictable fuel prices can quickly diminish profit margins, especially if the increase in fuel prices cannot be passed along to the customers. This poses a huge risk to the business, and greatly decreases the reliability of their revenue streams.
  • Economic Downturns: During times of recession or economic contraction, demand for travel decreases considerably, thus shrinking revenue and profit. This also includes times of disease or pandemic.
  • Increased Competition: New entrants in the market with more aggressive expansion could take away market share from Delta. Moreover, the new and improved low-cost airlines may lead to higher price competition, further eroding the profit margins.
  • Technological Disruption: Advances in technology could lead to new, competing travel methods that change the nature of the industry itself.
  • Labor Issues: Airline industry employees are often represented by powerful labor unions, which can disrupt operations, especially if they are not happy with current wages and benefits.
  • Operational Interruptions: Airlines are very sensitive to weather, maintenance issues and other problems that can impact flights, leading to a decrease in service availability.
  • Government Regulations and Trade Relations: Changes in legislation, including those on taxation, trade tariffs, or airline specific regulations can have an impact on the business, as well as international disputes and trade issues.
  • Geopolitical Instability: Events such as war, terrorist attacks and other conflicts can severely impact airline operations.

Business Resilience

Despite these risks, Delta has shown some resilience and its recent recovery, however, they need to be closely monitored for their long-term survivability:

  • Strategic Routes: They have focused on long-term routes that allow them to maintain stable revenues throughout the years.
  • Strong Financial Controls: Delta’s effort to control costs may improve its ability to weather economic and other related crises.
  • Customer Loyalty Programs: Their focus on customers via high quality programs will increase their capacity to keep their customers for the future.
  • Industry Consolidation: They have become one of the largest and stable players in the industry through a continuous effort at consolidation, which makes them more resistant to the vagaries of the airline business.
  • Focus on Sustainability: By using newer and more efficient aircrafts, and other initiatives, Delta will be better placed to survive and thrive in the long term.

Understandability: 2 / 5 The airline business is quite complex and difficult to fully understand. This is further complicated by the different forms of revenue generation, and unique nature of their profitability and capital structure. Here are some factors for giving it this rating:

  • Complex Operations: It is inherently difficult to assess airlines due to their operational complexities and volatile expense structure.
  • Financial Statements: Airlines require an understanding of the nuances of the financial statements, such as complex cash flow statements and balance sheets.
  • Unique Factors: The value creation for airline companies depend on the complex nature of how to generate revenue in many different ways from passengers, tickets, cargo, and other sources of revenue.
  • Interconnection: How the various parts of the system including hubs, connections, and pricing affect each other can be hard to wrap your mind around.

Balance Sheet Health: 2 / 5

The overall financial health of Delta is not looking as great. Here’s how I broke this down:

  • High Debt: Debt levels have been very high, and this is a major burden on profitability.
  • Negative Equity: The equity value of the firm is very close to being negative.
  • Capital Expenditure: Airlines require constant investment into new aircraft, which will create a high capital expenditure structure.
  • Variable Profits: They are highly dependent on outside forces that they can’t influence, leading to highly variable profitability.
  • Positive Cash Flow: They have recently started generating substantial cash flow from operations, this is a positive but may be reversed if external circumstances negatively impact them.

Recent Concerns / Controversies and Management Response

  • Debt Burden: Delta management has repeatedly acknowledged their high debt, and have stated their continued intent at reducing debt, this continues to be a problem.
  • Rising Fuel Costs: Fuel costs continue to rise, with global conflicts such as the Russia-Ukraine war and the Israel-Palestine conflicts increasing the costs further. Management have been carefully navigating these issues, using hedges, and improving efficiency to reduce their effect.
  • Pilot Shortages: There have been claims of a shortage in qualified pilots in the airline industry, and management is attempting to increase employee retention and training.

The company is making improvements at becoming more profitable and more resilient, however, they have to carefully manage their debt situation and external risk factors that can severely harm their business.