Delta Earnings: Higher Structural Costs Will Lead to New Equilibrium; Fair Value Down $1 to $40

We’ve lowered our fair value estimate for no-moat Delta Air Lines DAL to $40 per share from $41 to reflect incremental increases in the carrier’s persistent operating costs and slightly higher average fuel costs in the near term than we previously anticipated.

Despite a runup in the price of jet fuel over the summer, which dented profitability, the company reported earnings for the third quarter that were quite strong, delivering nearly $2 billion in operating profit and paying down some $724 million of debt. We assume fuel prices will moderate eventually; in any case, airlines make a practice of adjusting their forward ticket prices to incorporate changes in fuel costs (as they rise or fall). However, less volatile costs like labor and maintenance have been on the rise for Delta and its competitors, and we see these increases persisting over time.

CEO Ed Bastian said, “I fully expect the market will adjust to higher costs, as it has historically, and reestablish equilibrium,” referring to the overall increase in airline costs. The implication is that ticket prices will stay elevated, and while that probably won’t crimp demand in the next year or two as travelers continue to fulfill their pent-up wanderlust, for the average traveler, higher ticket prices will eventually and incrementally mute demand.

In Delta’s case, 55% of revenue in the first nine months of 2023 came from premium seats and offerings, and management noted that sales and bookings for them remain strong, extending beyond the normal summer and winter peak travel seasons. However, we have observed early signs of price pressure, particularly among competitors, on what Delta terms the main cabin. Today, as the company has more demand for its premium offering than premium assets to deliver, the outlook remains bright, but we anticipate updating our airline industry forecasts as more airlines provide earnings results and update their expectations.