Why high operating expenses were negative for Delta’s profit margins

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Impact on earnings per share (or EPS)

As mentioned in the last part in this series, Delta’s operating income reduced by 47%. It decreased despite an increase in yield and revenue due to higher operating expense.

In 3Q14, Delta’s operating margin decreased to 7.5%—from 14.9% in the previous year. Non-operating expenses also increased by 28% in spite of a decrease in interest expense. The increase was mainly due to the $134 million loss from getting rid of debt.

Delta reported an income tax expense of $222 million against a tax benefit of $6 million reported in the previous year. This  resulted in lower EPS for the quarter. Diluted EPS reduced by ~74% to $0.42 in 3Q14—compared to $1.59 in 3Q13.

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Except for Delta (DAL) and Alaska (or ALK), all of the top U.S. airlines—including United (UAL), American (AAL), Southwest (LUV), and JetBlue (or JBLU)—reported positive EPS growth. Exchange-traded funds (or ETFs)—like the iShares Transportation Average ETF (or IYT) and the SPDR S&P Transportation ETF (XTN)—hold some of these airline stocks.

Part7_3Q14_Operating margin

Higher special charges

However, most of the higher expenses that were incurred during the quarter aren’t recurring in nature. The extraordinary expenses during the quarter totaled $657 million—net of taxes. This compares to a net $157 gain recorded in 3Q13.

Almost 60% of the total extraordinary expenses was related to the retirement of 747 aircraft. This is expected to improve the profitability of the Pacific region. The breakdown of extraordinary expenses during 3Q14 is as follows:

  • $397 million related to the retirement of 747 aircraft as part of the Pacific restructuring initiative
  • $215 million of mark-to-market adjustments on fuel hedges
  • $87 million on debt reduction initiatives including extinguishing debt
  • $42 million gain on a litigation settlement

As a result, the adjusted operating margin—calculated by excluding expenses that are non-recurring in nature—increased by 2.6% to 15.8%. There’s an 8.3% difference between the reported and adjusted margin. The reported margin was 7.5%. The adjusted margin was 15.8%.

The MTM adjustments contributed to 3.1% of the difference. Restructuring and other expenses contributed to 5.2%.

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