The Delta Variant Slowed, Not Stalled, Delta's Recovery

No-moat-rated Delta (DAL) reported decent third-quarter earnings as the Delta variant surge in COVID-19 cases limited the business travel recovery, but the effects of the new variant were not as bad as consensus feared. Revenue of $9.2 billion beat FactSet consensus by 9.3% and EPS of $0.30 beat FactSet consensus by 96.6%. The two major stories were strengthening business travel demand due to office reopenings and cost inflation, particularly for labor and fuel. We are increasing our fair value estimate to $54.50 from $52.50 as we continue to believe the firm has structurally improved its non-fuel cost base and we expect softening oil prices in the long term.

Passenger revenue increased 34.7% from the prior quarter (63% of 2019) on an 11.4% increase in capacity (71.4% of 2019), an 11.0-point increase in load factor to 79.6%, and a 4.1% increase in yields (97.8% of 2019). Management indicated that it sees a path to fully restoring 2019 capacity in the latter half of 2022, which gives us confidence in our forecast that the firm can recover to 2019 levels on an annual basis by 2023.

The firm’s co-branded card continues to perform well; card spend has recovered to 115% of 2019 levels. Card spend is a major driver of loyalty program revenue, which is Delta’s highest-margin revenue stream. While loyalty revenue has not recovered to 2019 levels, it is within 10% of 2019 levels, and we see the high card engagement as a reason to be optimistic that the firm can return to a midteens operating margin.

Unit costs excluding fuel costs increased 2.2% to 11.67 cents per available seat mile despite the increased network. The primary driver of this was increased maintenance costs per ASM and relatively flat other fixed costs, such as employment, per ASM. We think cost-inflation is a risk, but the firm had about 20,000 retirements (about 22% of 2019 employment) in 2020 and these retirements were generally older workers with higher salaries than the employees Delta was bringing in.