"Changes" at Delta

Delta Air Lines (NYSE: DAL) came out of bankruptcy early this week. What emerges is virtually a brand new company with startling differences from the past: Fresh $4 billion in cash; annual costs reduced by more than $500 million; pilots’ pensions transferred to the government; planes with new paint jobs (flight attendants had new uniforms earlier); and no more takeover by a second-rate bidder from Tempe. These changes are exciting alright. But is Delta now cleared for takeoff to success?

The most remarkable change taking place at Delta is how its route map looks today. Domestic routes were cut, and widebody aircraft transferred to international flights. Delta also started flying to cities such as Kiev, Pisa, Santo Domingo and Managua—secondary markets, primarily in Europe and Latin America, that previously had no direct service from the U.S. Almost overnight, Delta’s domestic share of system capacity dropped from 75% prior to bankruptcy to around 63% today. Eventually, Delta sees half of its flying to be international.

The shift from domestic to international flights rests on the rationale that Delta would face less pricing pressures in international markets where there are fewer competitors, especially low cost carriers such as Southwest, JetBlue, and AirTran that for years had eaten away Delta’s domestic position. Going the international route is also a template for success, as demonstrated by Continental Airlines’ success in recent years—not coincidentally—in secondary markets of Europe and Latin America. Continental’s domestic capacity is only about 55% of its total, compared to around 63% for the other major U.S. carriers of American, Northwest, and United. Emulating Continental is thus Delta’s way to go.

But Delta is trying to change very quickly, on different fronts, from all directions. It is adding routes from not just one main hub, but two (Atlanta and New York Kennedy) or possibly three (Los Angeles). At the same time, it is renovating its airport terminals and upgrading inflight services. And just is case anyone misses the point, the current marketing campaign is called “Change.”

Employee morale is very high. Many analysts also share in the exuberance, pointing to rosy first quarter results that declared an operating profit of $155 million. However, to already declare Delta a success story this early is overly optimistic, because despite seemingly robust numbers, Delta may not be doing as well as management touts it is.

One area of concern is unit revenues (PRASM), a performance measure that shows where the airline’s position is in the market. The higher the PRASM, the better the airline’s ability to fill seats without lowering fares. The lower the PRASM, however, the less likely it is able to be profitable. Delta’s international expansions raised the question whether they will help improve PRASM. In the Atlantic and Latin America markets, where much of the expansion is focused, PRASMs saw year-to-year gains of +6.5% and +5.6% respectively. That’s good, because Delta is now generating more cash per seat than it did before. However, compared to other airlines, Delta’s PRASM gains are the smallest in the bunch, suggesting that it still faces pressures that keep the fares low.

In one region where Delta outshined its competitors is the domestic market—one in which it cut back capacity.

Certainly, you can’t determine whether an airline just coming out of bankruptcy will be successful based on its unit revenues alone. However, they are an indicator of how well the new business strategy is affecting the bottom line. Because unit revenue growth is smaller in comparison with other airlines, many of the high expectations for Delta may need to descend to a more reasonable level.