Jhe morning saw the first major earnings release of the first quarter earnings season, with reports from Delta Airlines (DAL). The stock breaks out after the results, or more accurately, after the comments that accompanied them. But investors should be careful when joining the buy; if anything, the jump looks more like an opportunity to sell than a reason to buy.
Delta lost slightly less than expected in the first quarter, but after appearing to turn the corner by reporting two straight profitable quarters in the second half of last year, is that cause for celebration? Probably not, but what’s keeping the stock trading about 6% above yesterday’s close as I write is that CEO Ed Bastian is very optimistic about the next quarter and anticipating a return to profitability.
Assuming he’s right, that’s wonderful for Delta shareholders. However, this optimism is based on the fact that we, the traveling public, have not backed down from the fare hike.
These price increases are justified by the fact that fuel costs have risen sharply at airlines, along with other unrelated costs. One could argue that the fuel cost impact is due to insufficient hedging in a sustained bull market for crude, but it would be too harsh to criticize a company for not accurately predicting moves in a volatile market. Some sort of fuel surcharge is perfectly understandable, or at least it would be if it were a temporary measure. As for the departure of the staff, that too was understandable. Airlines had very little choice given the unique circumstances they have faced over the past two years and the inflation and labor shortages that make rehiring so costly.
Where I am inclined to be less charitable, however, is Bastian’s assumption that the traveling public will continue to tolerate higher fares without any improvement in travel conditions or service. With the plethora of discount options available to domestic travelers in the US, that seems to be far from certain. Why should we pay more to be cramped and ignored on a ‘premium’ airline when you can pay less for the same thing? If there is an attempt to fix this by allowing more flights that are not completely full, or paying what it takes to replenish staff levels, either profitability will be further delayed or there will still be more price increases.
Eventually, even world-weary travelers will back off if prices continue to rise, so Delta will likely have to choose between lower margins or lower revenues. Add to the fact that there is yet another variant of Covid causing a setback in the return to normality, an issue that hasn’t really factored into Bastian’s optimism – I’m not sure the Delta’s future is as rosy as traders seem to be assuming in this morning’s premarket trading. Rather, Delta’s assumption that customers will continue to tolerate higher fares without service improvements that would significantly reduce margins is most important here.
Excessive optimism is nothing new for airlines. In 2020, when many of them went to government for taxpayers’ money, it was pointed out that the previous few years had been marked by big stock buybacks and big executive bonuses. The managers then seemed to assume that the good times would last forever. They spent money to get rich rather than improving their balance sheets or salting money for the bad times that history clearly said would come at some point. It’s not such a blatant example, but it’s part of a pattern of what some might call airline arrogance that has caused shareholders pain in the past. This time might be different, but if DAL shows significant gains over the next two months, it will do so without my money behind it.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.