Delta's response to rising costs: The economy's on our side

Key Points
  • Delta's fourth-quarter profits and sales beat Wall Street estimates.
  • Revenue is growing across Delta's regions.
  • Delta's stock is up 10 percent over last 12 months.
A Delta A350 plane
Leslie Josephs | CNBC

Delta Air Lines is betting a strong global economy will help it weather climbing fuel and other costs.

The second-largest U.S. carrier, after American Airlines, brought in revenue and profits in the last three months of 2017 that topped Wall Street estimates. It raised its profit outlook for 2018 by around 20 percent, citing the new tax legislation.

Delta said passenger revenue rose in all the regions where it operates, the first time it posted across-the-board gains in five years. The airline's shares rose 4.8 percent after the report was released, while its competitors also climbed in a rally that spanned U.S. airline stocks.

But Delta — like its rivals, such as American and United, which report later this month — faced higher fuel costs last year and is now grappling with oil prices at multiyear highs.

Fuel prices still climbing

Delta said its fuel expense rose $350 million in the third quarter and that it paid an average of $1.93 a gallon. It expects to pay around $2.05 to $2.10 a gallon in the first three months of this year.

"I think the biggest thing we have going in our favor in 2018 is a strong economy with a lot of optimism," Delta CEO Ed Bastian said on an earnings call Thursday. He admitted, however, that fuel "is a little bit of a wild card."

The U.S. economy grew 3.2 percent in the third quarter, the biggest increase for the July through September period in two years, according to the U.S. Commerce Department.

Corporate travel revenue last quarter grew at the fastest clip since 2014, the airline said, adding that it will likely continue this year.

Corporate travel will rise more than 6 percent this year, the highest growth rate since 2011, Deloitte recently estimated.

Earlier this week, Bank of America Merrill Lynch said the new tax legislation would boost business-travel spending this year and that would help boost shares of Delta, United and American, which are heavily reliant on corporate travel revenue. Delta said the tax law would likely spur more corporate travel spending.

But investors will task Delta to keep a lid on increasing costs, which the airline expects to rise 2 to 4 percent this quarter, not including fuel. Delta said it would try to trim costs for hotels, transportation and fleet management.

Higher costs will hurt its ability to grow profits in the first three months of the year, it said, forecasting earnings of between 60 and 80 cents a share, below the 83 cents a share forecast by analysts polled by Thomson Reuters.

Delta has been restrained when it comes to growing capacity and expects to upgrade to larger aircraft to meet some of the increasing demand. It expects to grow capacity around 3 percent this quarter, while increasing revenue per each seat it flies — a key industry metric — to a gain of 2.5 to 4.5 percent. Too much growth can lead to depressed fares, which tends to spook investors.

Passengers are opening their wallets

Not only are planes flying fuller, but passengers are willing to shell out more for higher fares. Delta, like its competitors, has sliced up its economy cabins and rolled out new premium cabins to encourage passengers to pay for more room on board and other amenities.

Delta's president, Glen Hauenstein, said its so-called branded fares generated $200 million in the fourth quarter, and revenues from upselling passengers on first-class seats and its Comfort+ economy seats increased between 25 percent and 30 percent.

Those types of fares will contribute $350 million in incremental revenue this year. Delta has said its bare-bones basic economy fares, which offer little flexibility and no free checked bags, are intended to drive passengers to a more-expensive, full-service economy fare. Delta is taking those fares global this year.

Revenue from its co-branded credit card program with American Express is also on the rise. It said it logged more than 1 million signups for SkyMiles credit card accounts in 2017, an annual record. Delta and other airlines make money by selling airline miles to credit card issuers and those issuers, in turn, receive new customers.

No taxes ... yet

Because of years of losses in the past, through what's called deferred tax assets, Delta and some other airlines don't pay taxes. The airline could become a taxpayer in 2019 and 2020, it said, in which case it would pay at the new lower rate.

Other challenges ahead

There are some curveballs Delta has to face this year. At least 75 Bombardier jets it ordered are stuck in a trade dispute with rival plane-maker Boeing, which complained that its Canadian counterpart sold them to Delta below cost and received illegal government subsidies for the program. So far, the Trump administration has sided with Boeing and recommended tariffs of almost 300 percent on the planes, which seat about 100 to 125 passengers.

A final ruling is expected later this month, and Delta said it doesn't expect to take delivery of the planes this spring as planned. To match demand, Bastian said the airline is investing in maintaining MD-88 jets, which it intends to retire soon, "around a bit longer than we were otherwise anticipating."

Delta recently agreed to buy 100 single-aisle Airbus jets, but those don't arrive until 2020.