Analysts are expecting a huge boost in profits for Delta Air Lines in 4Q15 and beyond. The company’s EBITDA (earnings before interest, tax, depreciation, and amortization) margins are expected to have improved to 21% in 2015 as compared to 10% in 2014. Analysts are expecting further EBITDA margin expansion to 25% in 2016 but a decline to 24% in 2017.
However, investors should remember that the airline industry is cyclical. EBITDA margins are at all-time highs, and analysts are predicting that the cycle may have peaked, leaving little room for margin expansion beyond 2016. It’s important to keep in mind, though, that positive factors like falling crude oil prices may lead to upward revision of margins.
Declining fuel costs, reduction of hedging losses, and improving capacity utilizations are the key factors that are expected to lead to margin expansion.
The airline industry is famous for destroying capital. When an industry turns profitable, markets reward it amply. However, markets are just as quick to punish airlines’ stocks on the first sign of a downturn. Thus, investors should keep a close eye on airline profitability and, more importantly, on analysts’ forecasts for the industry’s future margins.
For 4Q15, Delta expects its fuel costs to have declined to $1.82–$1.87 per gallon. Operating margins are expected to have increased to 16.5%–17.5% in 4Q15, as compared to 12.6% in 4Q14.
Demand growth, fuel savings, and cost discipline have helped Delta achieve margin expansion for the fifth consecutive year. For the upcoming year, the company expects to see a 36% drop in its fuel cost to ~$1.45 per gallon, as compared to 2015. Operating margins are expected to remain in the range of 16–17%.
Improving capacity utilization
DAL’s restrained capacity growth and targeted capacity cuts in international markets have helped improve capacity utilization. This, is turn, helps margin performance. Better utilization during the last quarter can also be one of the reasons behind the company’s positive forecast of a slower PRASM fall during the fourth quarter of the year.
Hedging losses fall
Delta (DAL) lost about $1 billion in hedges in 2015. However, the company continues to keep itself hedged. For 2016, DAL expects hedging losses to fall to $500 million as it is now only 5% hedged and has shorter hedges, giving it more flexibility. This is one of the key factors contributing to analysts’ expectations for DAL’s margin expansion in 2016.
Investors can gain exposure to airlines through the iShares Transportation Average ETF (IYT). IYT has 5.4% of its holdings in Alaska Air Group (ALK), 4.7% of its holdings in United Continental Holdings (UAL), 4.3% of its holdings in DAL, 3.9% of its holdings in Southwest Airlines Company (LUV), 3.6% of its holdings in American Airlines Group (AAL), and 1.9% of its holdings in JetBlue Airways (JBLU).