Delta Air Lines at Raymond James Global Airline Conference

Feb. 6, 2012
28 min read

Corporate Participants

* Ed Bastian

Delta Air Lines - President

Conference Call Participants

* Savanthi Syth

Raymond James - Analyst

Presentation

SAVANTHI SYTH, ANALYST, RAYMOND JAMES: Jim mentioned that he finally started to take notice of the legacy space, the space he ignored for some time. And the reason had been in the past that legacy airlines have given back all the earnings that they made in a recovery period in the rest of the cycle.

But there is definitely a change underway, and Delta is leading that change in focusing away from marketshare to profitability. And it is apparent in the fact that they -- a year after the market recovery in 2010 they reported another strong earnings in 2011. And that was despite a 40% -- almost 40% increase in fuel. You had the tragic tsunami and earthquake in Japan. And also all the macroeconomic issues that we have seen in Europe and elsewhere.

This is definitely a new industry. And to talk more about that we have Ed Bastian, the President of Delta Airlines, to share more about some of the progress and the plans that they have here.

ED BASTIAN, PRESIDENT, DELTA AIR LINES: Thank you, Savi, and good morning everyone. I appreciate you being with us this morning or on the Web. This is -- if I'm not mistaken, this is being broadcast, so I would like to say good morning to all the listeners that are calling in. I remind you all that we are on a public call here.

This is our Safe Harbor statement, so we will be presenting forward-looking estimates and using some measures that are not necessarily GAAP accounting. And to the extent you need any calculations or assistance with reconciliation you can either refer to the website or call our Investor Relations group.

We have -- also with me this morning Ms. Jill Greer, who is head of Investor Relations at Delta, and Mr. Hank Halter, who is our Chief Financial Officer. So we will be around this morning doing some one-on-ones so anyone that wants to stop by and see us, feel free.

So as Savi said, I think she did my introduction for me, thank you. 2011 was a very interesting, interesting year for us. And I would say it is a remarkable year. When you consider the historical challenges this industry has faced and when you look at the headwinds that we faced in 2011, if there is any question that the model is changing and shifting it should hopefully be answered by our results in 2011. And we hope to continue to answer that question that, yes, this time is different in 2012.

2011 we faced a 30% increase in our fuel prices, over $3 billion in higher fuel. We had economic weakness in our two largest markets, both in the US, which the growth was quite sluggish as we all know, and then even worse in Europe where we were facing a recession. On top of that we had the tsunami in Japan and the tragic effects, our third largest market where we had a significant reduction in travel into the Japanese market.

And on top of that all, we had war and unrest brewing throughout the year in the Middle East. And despite that fact pattern, and that fact pattern that you would have any other time said that the airlines must be a basket case and must be struggling for survival, in fact, Delta posted what I would say was a remarkable set of results.

Our profit in 2011 was $1.2 billion. We generated a premium in our revenues to the industry throughout the year, and we continue that pace into 2012. We fully recovered -- the first time in our history fully recovered that run-up in fuel price in the current year. And we are delivering an industry-leading product, and it is hats off to the Delta employees for the great job they're doing. And I will show you some slides to that effect here.

We created $1.6 billion of free cash flow that allowed us to continue with our delevering strategy. We brought our net debt levels down at the end of the year down to $12.9 billion. We started on this journey a couple of years ago when our adjusted net debt was $17 billion, and we laid out a goal to get it down to $10 million in adjusted total net debt by the end of 2012.

It is going to take us about six months longer than we originally projected, but by the middle of 2013 we will be down to $10 billion in adjusted net debt. And we made a big down payment on that again in 2011.

Then, most importantly to you, our investors, we generated a 9.1% return on the base of invested capital that you provide us to operate with. The second year in a row that we not only covered but exceeded our cost of capital.

Our fourth-quarter results are presented here. We generated a $380 million net profit in the quarter, despite the fact that we had over $500 million of fuel price pressure in the quarter over the fourth quarter of 2010, and that we more than doubled the profits that we had in our fourth quarter.

Our unit revenues were up 12%. Our operating margin was up 2.6 points to 7.7%. And as I mentioned earlier, our adjusted net debt was reduced to $12.9 billion.

And this -- what you see happening in the industry is a separation from the pack. And you see the strong creating stronger results and stronger profits that are giving us the ability to invest back in better service for our customers. Delta Airlines led all the majors, the large network carriers, in operating margin in 2011 with a 6.4% operating margin, $1.2 billion of profit.

And we garnered momentum as we went through the course of 2011 and a strong momentum going into 2012. If you look back at our quarterly run rate over 2011, we had a very difficult first quarter of 2011, too much capacity in the trans-Atlantic and some other steps that we needed to take to adjust the business.

So we turned what was a $400 million loss quarter in the first quarter of 2011 into a net profit for the full year of $1.2 billion. And based on the guidance that we provided last week with our earnings call we can expect to see a substantial improvement in our first-quarter 2012 results as a result.

So what is the landscape for 2012 and how we are we looking at it? First of all, from an industry perspective we anticipate it is going to be a relatively slow GDP growth. We are looking at GDP growth globally in the 2% to 3% range. We are anticipating the continuation of difficult times in Europe. Now we have taken corrective action and I will talk a little bit about what we have done in Europe and the results of that here.

We expect fuel prices to spike -- the sluggish outlook to remain at historically high levels. In fact, we're expecting they could likely grow yet again in 2012. And this has been a fairly significant change in the mindset of how we operate this business.

We are no longer in the business of just expecting the forward curve is going to stay flat and set our operations, and then come back and explain to you why we missed our plan because fuel prices were the culprit. We're going to expect fuel prices are going to continue to escalate, continue to rise, set our capacity plans accordingly. And then in the result fuel prices don't rise as high as we are expecting, they turn around and we have a better end result, that is okay. We are willing to leave a few dollars on the table as long as we're ready for a difficult fuel environment with our capacity structure.

We are looking at industry restructuring in front of us. Obviously, we all saw the difficult news that American announced yesterday. We expect the industry to continue with the reshaping that we have seen over the course of the last several years.

For Delta specifically we are going to remain cautious and disciplined on our capacity. We have a system capacity reduction of 2% to 3% for the full year. For the first quarter of 2012 we were expecting a system capacity reduction of 3% to 5%. And that is even given the fact that this year we have an extra day due to leap day or leap year in the first quarter. so on an apples-to-apples basis our system capacity in the first quarter would be down 4% to 6%.

We continue to see great momentum in the corporate revenue and the base of revenue, as well as the share gains that we've been achieving.

And cost, while we talked about fuel separately, and we will have a discussion about that, we are also seeing inflationary pressures in our non-fuel costs that we need to take corrective action and continue to take action to nip where we can.

This is the playbook to grow unit revenues. We have been doing that and we will continue to do that. Improve the productivity of the operation -- all levels of operation, not just the non-fuel areas but fuel as well.

And take the cash that we are generating to do two things. We have been -- about 50% of the cash we have been generating we have been investing back in the business to improve the quality, the operation and the product we are creating. Not to grow the business, but to improve what we do today. And use the other half of the cash to delever the balance sheet to pay down the debt.

Now this is a picture of the revenue performance we have had. And I have taken a little longer snapshot here then we gave you just to give you a perspective. Because when we went into the merger one of the big promises of the merger was that we were going to see revenue synergies. And I think the market was waiting to see if the synergies on the revenue side particularly are going to materialize, and I'm glad to report that they have materialized, albeit it has taken a little bit of time to develop.

On a system basis, in the fourth quarter of 2007 the Delta and Northwest systems together generated unit revenues at about 98% of industry average. In the fourth quarter of this past year, we generated a 102% index to the industry on unit revenues. And if you could look across the landscape you can see that improvement has taken shape over every one of our large geographies.

Our domestic business is currently at a 106 index to the industry. You can see a substantial improvement in trans-Atlantic, where we moved from a 92% index to 101% in the fourth quarter of 2007.

Our Latin business is still relatively small. It is about 5% of our total revenues. And we have talked openly about the need to improve and enhance and expand our Latin theater of operation. We invested last year both in GOL, the largest domestic airline in Brazil, as well as in AeroMexico, the flag carrier of the country of Mexico, for this very purpose to make certain that for the future we are well-positioned to improve our unit revenue productivity in the Latin and South America marketplaces.

And, finally, in the Pacific you can see the strong improvements we have seen over the course of the last several years, where the Pacific unit revenue was running at an index of 103%.

And if I turn to the 2012 numbers as well, we are continuing to see that in 2012. Our January month unit revenues are up 15%, systemwide on a year-over-year basis. And we have seen double-digit year-on-year improvements in all regions, all geographies of the world, led by the trans-Atlantic. Our trans-Atlantic unit revenues in the month of January are up 18%.

So strong performance in 2011, continued momentum going into 2012 showed the impact that Savi was mentioning of the steps we have taken, the capacity that we rationalized, and the improvements we're making to the service that we are providing our customers.

Key to generating a revenue premium in this industry is to deliver a product that is reliable, is of high quality, and great service from our great employees. And when you look at the operating performance we have been able to post here over the last year it is nothing short of remarkable.

This is a snapshot of our key operational measures from the last half of 2010, which was really at the point where we had finished the integration of the operations between Delta and Northwest, and by our own measure were falling short of some customer expectations in some of the difficult times you have as you integrate systems and people, processes and technology. So now that we are on the other side and we have fully integrated, fully fixed all of those operational challenges you can see the progress we have reported.

We have had over a full point of improvement in our completion factor. Probably the most accretive thing we can do is to actually deliver what we promise and complete those, like 1 full percent of our schedule we enhanced in 2011 over 2010 by being able to deliver the operation.

We have improved our on-time arrivals from 77% in the last half of 2010 to almost 85% in the last half of 2011. And even more remarkably when you look at the improved bags performance, there is a 35% reduction in lost bags, and bags not lost necessarily but bags not on the flight with the customers, bringing that index down from 3.49 to 2.66.

This is some of the best performance we have ever had in our history. And arguably we have had some benefit of the weather. The weather gods have been kind to us this year. And we will continue to pray to them that they continue to shine on us.

But it is more than just weather, because everyone has been generating weather, it is really the performance of Delta. And, in fact, it was mentioned -- this is a picture -- a couple weeks ago the Wall Street Journal ran an article in The Middle Seat column, Scott McCartney, of who -- what airline has been doing the best performance in 2011 of all the majors. And you can see Delta rated at or near the top of that list across every one of the key operational measures.

So we are pleased with that progress. We know we have more work to do. We are going to improve it as we go into 2012. But it really sets the platform for that improved financial and revenue performance that we are posting here to you, our shareholders.

On the corporate sector, we have had a good year. This is a picture of our fourth-quarter corporate revenues. Our corporate revenues in the fourth quarter were up 15% despite the fact that we had almost 4 points of lower capacity in that quarter over the fourth quarter of 2010.

And when you look down the chart and you can see the sectors and regions that are providing that growth -- financial services up 17%, manufacturing up 17%, technology up 13%. Those three sectors represent roughly half of our total corporate revenue base, and they are all growing at healthy double-digit levels per

You can see the two lowest sectors -- the two sectors that have had only modest improvements. That is in -- banking and defense are actually our two smallest sectors that we serve in the corporate space. Banking is only 3% of our total business and defense is only 3% of our business.

So this picture to me is as good a picture as any one when we talk about the disconnect between Wall Street and Main Street, what is happening out there in the corporate world and the relative health of corporate travel as we look into 2012 as compared to what you might read in the headlines of what is going on on Wall Street.

Another area of revenue improvement for us in 2012 will be the continued rollout of merchandising initiatives. We are targeting a $1 billion enhancement in our total merchandising revenue by 2013. That was measured as against 2010 revenue base, and we are right on track. We are expecting in 2012 a $400 million improvement in those revenues.

And they will come from everything from a a full rollout of Economy Comfort, which we now have across our entire international fleet, but we are introducing into our domestic fleet as well, and that will be available for sale starting in the spring.

First-class upsell, where customers can confirm their first-class upgrades. We generated roughly $100 million of incremental revenue in 2011 from being able to sell customers what they want, which means a confirmed first-class upgrade proposition. And you can go right on down the list.

What is underpinning a lot of these initiatives are two things. First of all, it is a re-platforming of our technology base, and Delta.com, which we will be rolling out in spring of this year. The first new complete re-platforming of Delta.com in many years. That is providing us enhanced capabilities.

And, secondly, the scale of our business. We carry 170 million passengers a year. And when you have an operation of that scale and that size the incremental revenue improvement you can make by being a better direct-to-consumer marketer -- we are world-class B2B company, as you can see on the earlier chart how we serve the corporate space.

But by being an equally world-class B2C marketer, a direct-to-consumer marketer, you can see the opportunities on a scale business -- 170 million passengers a year are generating that improvement. And these revenues truly fall to the bottom line. There is very little marginal cost attached to offering these services.

We have had a relatively good year on fuel. You never -- high fuel levels are never good for anyone. But when you look at the fuel performance that we posted in 2011, as well as the fourth quarter of 2011, we had a very good year. Our all-in fuel cost per gallon in the fourth quarter was $2.97, a full $0.19 better than the industry composite for the fourth quarter. That generated about a $150 million advantage in the fourth quarter alone relative to the industry.

And that is an improvement that we have been seeing over the course of the entire year. Our fuel cost per gallon in 2011 was $0.06 better than the industry as a whole. That is a $240 million improvement. So while there is a lot of debate in the industry as to whether hedging pays off, whether it is worth the cost, I can tell you for Delta it is a strategic important -- of strategic importance that we do manage and control what we can. We generated a net of any cost of premiums a $450 million benefit in 2011 by the fact that we were hedging our fuel costs.

We have more work to do on our non-fuel area, however. When you look at where our non-fuel costs where for the business the years following our restructuring, 2007 right up through 2010, we averaged somewhere about $0.0840 per seat mile.

And as we look to our estimate for 2012 where we expect our non-fuel cost to be of $0.088 there is about a $0.40 that we're targeting for long-term structural improvements to bring those costs down.

They're going to be coming out of three broad categories. First we are targeting about a $250 million improvement in maintenance efficiencies. It is going to come from the fleet. We announced last year, and we will start taking delivery next year, of the Boeing 737-900ER. It is going to allow us to retire some older equipment and improve and simplify the footprint of our maintenance fleet.

We're going -- we announced a joint venture with AeroMexico where we're opening a MRO in Guadalajara. It is going to help us with further improvements in our maintenance efficiency.

We're also going to look for additional opportunities to simplify the fleet. Once we -- or now that we have the full Delta Northwest merger behind us, we do have probably the most complex fleet footprint in the industry -- we have the largest fleet footprint in the industry, so there is a lot of opportunity there to enhance it.

Secondly, in the employee area we are targeting about $300 million of annual improvements now that we are all one company. We have worked through all the labor representation issues. They're all resolved. Delta has emerged, and we are proud of our people for maintaining their direct voice with management. Only our pilots here are unionized.

In fact, I should mention, Mr. Doug Ralph. I am sorry, Doug, I forgot to introduce to at the front. Doug is a member -- a Delta pilot, a member of our association. He always joins us at these conferences. A great relationship with our Delta pilots.

We also have a direct and great relationship with all of our employees. And now that Delta and Northwest is one large family, if you will, we are going to be able to simplify, harmonize, structure work rules across the two airlines. We have had to keep them separate until we completed the labor representation issue.

We are going to be looking at other ways to reduce headcount. And we are considering, and I would expect we will probably be announcing, another early-retirement opportunity for our employees. So yet again we can offer employees the opportunities if they want to retire. And we will probably be limiting the backfill of those employees, so that will further enhance the productivity that we will be able to deliver.

And, finally, on the fleet, the one area of the business that I think needs further work -- the most amount of work is still our small gauge aircraft, and that would be our 50 seat footprint. We today fly 350-seat regional jets throughout our system. And we have been reducing them at a rate of somewhere about 50 per year over the last several years. I expect that trendline is going to continue over the next several years.

And that is going to be an opportunity for us as well as a challenge for us as we work with our Delta -- good Delta Connection partners. But we need to find a way to provide lift to customers that is cost effective. The 50-seat product, candidly, with fuel products prices at these levels just doesn't work for us.

We are making investments in the business. The revenue improvements you have seen have been because we are investing in going after delivering products to what customers need. When you think about what Delta is doing, it is -- it is wise capital investment, if you will. We are spending $1.5 billion of capital. So it is not capital to grow the business, it is capital to improve the business.

We're going to be opening in the spring a new international terminal in Atlanta. It is going to be state-of-the-art, world-class. It is going to substantially enhance the international experience for our Atlanta destination and origin customers.

You know that we closed our deal with US Air in December, and we will be building out LaGuardia and connecting Terminal C and Terminal D at LaGuardia, providing 50% of the flying out of LaGuardia by the end of 2012. 50% of LaGuardia will be Delta. And we will be putting roughly $100 million of capital into the connection so that we have a secured connection between Concourses C and D, and one overall experience for our customers. It is going to be a great experience.

We are building out, also, JFK. We're about halfway through the construction of our new international terminal at Terminal 4, the IAT facility. That is going to be scheduled to open spring of next year. So over the course of the next 18 months, three of our largest facilities are undergoing significant enhancements, all of which is in our capital forecast, our capital plans, and substantial improvements to our customer service.

We are rolling out on our widebodies in our international fleet, the full flat product, as well as an improved and enhanced coach product across all of our international network. We will have over half of our fleet in that configuration with the widebody, full-flat Business Elite seats in service by the end of 2012.

And as I mentioned, debt continues to be a -- derisking debt, rather, continues to be one of our major financial goals, and this shows the trajectory that we are on, $17 billion of adjusted net debt in 2009. People thought we were a little aggressive to say that we wanted to bring that down to $10 billion. And we are confident we can, and we are showing you that we are going to deliver on that.

The other benefit, as you all know, is not just taking the risk out of the business, it is reducing the cost of the business. We expect to save about $500 million in our overall interest bill as we go through this process. So the target of our interest costs by 2013 is $800 million. It was $1.3 billion in 2009, savings that fall directly to the bottom line.

So this is our plan for 2012. We had a very strong year in 2011 despite the massive tailwinds -- headwinds, rather, that we faced. We are proud of our employees. We are proud of the hard work. We are proud of the persistence and the obstacles that they faced that they turned into opportunities.

We're going to continue to be very cautious. This is not an environment that we want to grow into. You're not going to see growth from Delta in any region of the globe. We're going to continue to post unit revenue premiums to the industry, at the same time work to continue to reduce cost and reduce risk across the business.

So thank you for the opportunity to speak to you this morning. And I would be happy to take any questions with the time remaining.

Questions and Answers

UNIDENTIFIED AUDIENCE MEMBER: (inaudible - microphone inaccessible).

ED BASTIAN: The question was -- when do legacy carriers start to grow again? And in the face of $100 oil, just what is the forecast? I would say at the present time there is no growth projected. The improvements we are seeing are in the bottom line and our focus is on returns not marketshare.

I think the -- it is always easy in this business to grow it. It is very difficult to manage it and rationalize it as we are doing. So the returns and the progress you have seen, I would say, the principal factor in there is the fact that not only we went through a successful merger, but we are able to manage capacity with discipline. We're down from where we were in 2007 about 15% in total size -- Delta, Northwest, Independent there to where we are today.

I would say we are going to -- we're going -- there are strategic opportunities to grow. Latin and South America is one of those. They are economies that are growing faster than the GDP growth -- faster than the capacity can sustain in those regions. So we probably are going to continue to look in Brazil. We will look in Mexico. We will look in Argentina, some of the regions in South America, the Caribbean. We see some good growth prospects.

But they're going to be relatively modest. I would say over the next three to five years you're going to see China as an opportunity. As visa waivers and we facilitate it through our government supports some additional travel opportunities for Chinese residents to come visit this country, I would say you're going to see some growth coming out of China.

But it is going to be modest. The other factor and the overhang that we face is Europe. And I think when we look at our European capacity in 2012, I think we're down 7% from where we were in 2011.

So at some point in the future working with our partners there may be modest growth there -- opportunities. But I would say right now any growth would probably come from either developing markets, which are small, but important to us, or if the industry leaves any white spots and we opportunistically jump into it like we are doing here at LaGuardia.

UNIDENTIFIED AUDIENCE MEMBER: (inaudible) comment a little bit more about New York. New York has always been a very fragmented market. (inaudible). Where do you see this market evolving over the next five years specifically? How much more capacity do you see (inaudible)?

ED BASTIAN: Well, New York is a great opportunity for us. And one reason why it is a great opportunity, not only is it the largest aviation market in the world, but it is also a market that Delta has historically underperformed in.

We estimate that we're somewhere between $200 million to $300 million a year of unit revenue deficiency to some of our larger network competitors, primarily because we didn't have the destinations that customers wanted to travel to. We didn't have access to Heathrow until very recently. We didn't have a Pacific franchise until very recently. Latin America has been soft for us.

So now that we are able to offer the scale and the opportunity to New Yorkers to travel anywhere in the world, particularly our big corporates, you are seeing a massive amount of share that is moving our way. LaGuardia, we think is a great opportunity.

The Terminal C, the US Air facility today is vastly underutilized. They fly a lot of very, very small regional planes at that facility, essentially protecting slots. And I think as you look to the next year or two you are going to see a substantial upgauge at that concourse. And we're bringing either two class regional jets with 76 seats or a mainline aircraft into those markets throughout upstate New York, the Northeast.

We are going to be serving -- 48 of the top 50 markets that New Yorkers fly to out of La Guardia is going to be on Delta at LaGuardia.

So big opportunities. I think our forecast for 2013 is to bring 2 million more passengers a year through Terminal C, as we upgauge that facility from what is utilized today. And that revenue pool is a lot richer and a lot more opportunity. And it is going to give us opportunities over at JFK too. Because JFK today where we have a split operation, both the domestic and international, we are going to be able to shift some of our domestic flying to LaGuardia.

That is where particularly business travelers want to fly to. They don't want to fly to JFK, they want to come into LaGuardia. It is the most convenient airport to come into. And we're going to give them the product that they want in this market.

Internationally, once we get the new facility opened, I think you're going to see international growth opportunities here in New York too.

UNIDENTIFIED AUDIENCE MEMBER: (inaudible - microphone inaccessible).

ED BASTIAN: I'm having a real hard time hearing the end of it. How do we view Canada?

UNIDENTIFIED AUDIENCE MEMBER: (inaudible - microphone inaccessible).

ED BASTIAN: We have a good franchise in Canada, and a lot of it is the legacy Northwest franchise serving interior points throughout Canada. We don't see Canada as a major area of growth and that is why we partnered with WestJet, because WestJet is a great airline serving Canadians, and we would rather partner with a great home or local carrier than to provide feed onto our US network rather than going in and trying to grow it ourselves.

SAVANTHI SYTH: Thank you.

ED BASTIAN: Great, thanks everybody. I appreciate it.

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