Delta Reports Difficult Q2 but Able to Cut Costs

No-moat-rated Delta DAL reported a difficult second quarter, and our fair value estimate for the stock is $42.50 per share. While we are expecting that a robust recovery in air traffic will not begin in full until a COVID-19 vaccine gets distributed, the fact that daily TSA traveler throughput has held up at roughly 25%-30% of 2019 levels despite an increase in the daily U.S. new cases suggests to us that the worst days are behind Delta.

Our fair value estimate is sensitive to the degree of free cash flow burn in 2020 and the pace of the recovery, and second-quarter results provide some indications of how difficult 2020 will be. Second-quarter revenue declined by roughly 88% but were higher than management had expected; previous guidance had projected negative second-quarter revenue due to refunds. We are impressed with loyalty revenue from cobranded credit card spend, which was a bright spot and declined by 44%. We note that Delta’s frequent flyer program needs to continue engaging with grounded business travelers or to use the program to develop a stronger premium-leisure market to be successful in the long run. While current metrics probably aren’t especially meaningful due the the abnormal nature of the quarter, we thought it was encouraging that frequent flyer miles were utilized at somewhat-similar rates to 2019.

We are impressed with Delta’s expense management so far. Excluding two large noncash expenses and the CARES Act contra expense, the firm hit its target of reducing total expenses by 50% from the linked 2019 quarter. Much of the cost-savings came from lower fuel expense, which is tied to oil prices and the amount of aircraft utilization. The oil market has rebounded since April and the company intends to increase its schedule, so we think that the firm will need to continue reducing pay and headcount to keep operating expenses at 50% of 2019 levels.

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