Delta: The real strength
behind the brand June 2019

Delta Air Lines was the one to initiate the last stage of consolidation of the US airline industry — long-awaited since the Carter deregulation Act of 1978 — with its merger with Northwest in 2008. The United/Continental and American/US Airways mergers followed in 2010 and 2013 respectively and the industry really started to make profitable returns from 2015. But Delta had the head start, and in the last decade has beaten its legacy competitors on most financial measures: superior margins, returns on equity, debt reduction, and returns to shareholders. Can this continue?

Delta has built a very strong consumer brand. It is the sixth “most relevant” company in the US according to consultants W20 Group’s 2018 ranking — up by five places on the previous year and behind Facebook, Microsoft, Google, Amazon and Apple (but above Boeing and FedEx, ranked 12th and 14th respectively). Brand Finance in its ranking of airline brand values put Delta in the top spot for 2019 at over $10bn, overtaking American for the first time.

One of the reasons behind this strength, according to marketing guru Peter Horst writing in Forbes Magazine, is a power of alignment between its customers and employees: it broke with the NRA amidst the gun control debate and flew protestors for free in March last year stating that “our values are not for sale”; Delta was one of the first in the industry to have a black, female captain.

The management considers that the real strength behind the brand is the company’s unique cultural relationship with its employees — an underlying facet of the company through most of its history. Comments of Delta’s founder, CE Woolman (VP and CEO 1928-1966), that “An employee’s devotion to his or her company, dedication to the job and consideration for the customer determine a company’s reputation” are echoed by the current CEO, Ed Bastian: "When you take care of your employees, they will take great care of your customers, who then reward you with their business and loyalty. Every major business decision we make at Delta is based on that philosophy, and it has been very successful for us."

This attitude seems to be reciprocated by the staff. Using feedback from the company’s own employees, career information website comparably.com’s 2019 annual survey ranked Delta’s executive team in tenth place — well above Southwest (at 29) the only other airline to appear in the top 50 — and named Ed Bastian as one of the “Best CEOs for Women” and “Best CEOs for Diversity”.

Customers too respond with loyalty. Although Delta only achieves a three star rating at Skytrax, it pushed Alaska from the top spot in The Points Guy’s annual ranking of US carriers in January, and its FFP SkyMiles regularly ranks as the best of the US carriers' loyalty programmes. In presentations at its investor day last December, management highlighted that active membership of SkyMiles is up by more than 30% since 2012, these members provide around 60% of passenger revenue and that the revenue premium represented by SkyMiles travellers has risen by 11 percentage points in the past six years.

The company has also concentrated on the quality of its offering and boasts industry-leading safety, reliability (85% on-time performance and 99.6% completion factor, significantly below average lost baggage rates) and, with a 45% domestic net promoter score (NPS) in 2018 (up from 40% in 2016), record customer satisfaction. And high NPS leads to higher revenues: Delta achieves a yield premium against its peers in most route regions (except perhaps on Latin America where historically it has been relatively weak — see charts).

The net effect of has been an ability to create what it describes as an increasing diversity in revenue generation, with a significantly larger portion of total revenues coming from higher-margin revenue streams. In 2018 for the first time it reported that back-of-the bus (Main Cabin and Basic Economy) provided less than 50% of total revenues.

Since 2011 group revenues have grown by 25% (or 3% a year) but Main Cabin revenues have fallen by 4% and now account for only 46% of group revenues down from 63% at the beginning of the decade (see chart). Over the same period it has seen premium product revenues grow by 150% (15% a year) to account for 35% of the total up from 18%.

Over the period it has been developing its inflight product segmentation, creating what it refers to as “best-in-class premium experience”; Economy Comfort was introduced in 2011, First class “upsell” in 2012, Comfort+ in 2015, Premium Select and Delta One Suite/First Class upgrade in 2017. The proportion of premium seats has grown from 9% of the total to 28%, and the company expects it will account for 30% by 2023.

One of the other higher margin revenue streams that has grown strongly over the period is marked “Amex contribution”. This has doubled since 2011 and now accounts for 8% of total revenues.

American Express

Delta’s relationship with Amex, running since 1996, primarily revolves around co-branded credit cards for SkyMiles members. In May the two announced that they had renewed the agreement early “to create industry’s most valuable co-brand portfolio” and extend it to 2029.

The agreement allows American Express to market using Delta’s customer database and cardholders earn mileage credits for making purchases, may check their first bag for free, are granted discounted access to Delta Sky Club lounges and receive other benefits while traveling on Delta. Additionally, participants in the American Express Membership Rewards programme can swap their points for mileage credits in SkyMiles.

The contribution from the agreement has doubled from $1.7bn in 2012 to $3.4bn in 2018, while the number of Delta-Amex cards has grown by 50% in the period and the amount of money spent on the cards has increased at an annual average 12.5% to reach $92bn. In the announcement of the renewal Delta stated that it expects the Amex contribution from the relationship to double again — to $7bn — by 2023.

Delta also is an Amex card accepting merchant — with no cash “dam” (a base limit of revenues for future travel retained by the card issuer). Also, intriguingly, has its own Amex charge card with which to pay for jet fuel having a modest credit limit of $1.1bn).

Great Runway of Opportunity

The company’s December 2018 investor day presentations show considerable optimism using the soubriquet of a “Runway of Opportunity”. They describe describe initiatives to grow and diversify revenues and margins — the latter mentioned as a business imperative (as after all margins have slipped from the peak in 2015).

Delta prides itself on the positioning of its domestic hubs. Atlanta is the world’s largest hub airport with 107m terminal pax in 2018 (although soon probably to be overtaken by Beijing). For Delta it provides access to 80% of the US population within two hours journey. Its Salt Lake City hub it describes as its gateway to the West, while the former Northwest bases in Minneapolis St Paul and Detroit respectively provide Northern domestic coverage with a strong corporate base and a premier midwest connecting hub.

But these are domestic mid-continent hubs, and Delta has missed out historically on international connectivity through coastal gateways. In the last ten years however it has built its presence in New York (the gateway on the Atlantic) with a near doubling in peak day departures, increased its domestic revenue share position from 3rd place to 1st and improved profit margins by 18 percentage points. It is extending this expansion policy to Boston, Seattle and Los Angeles hoping to replicate the performance in New York.

Secondly, it is going through a major fleet renewal programme and gradually increasing fleet gauge — primarily to take advantage of lower costs per seat. The current fleet has an average age of 15.6 years, but 35% of the mainline jets are over 20 years old (including some pretty ancient MD80s, 757s and 767s).

Delta was the launch customer for the A220 in the US when it placed an order for 75 of the type in 2016. Nine have been delivered, which it is operating with 109 seats in a three class configuration: 81 are on firm order with 50 options. These are being used to enable retirement of 50-seat regional jets and replace 76-seat CRJs. The 149-seat MD80s will be gone by the end of 2020, while Delta has 153 A321s on order which it operates configured with 194 seats in three classes. By 2023 it expects that 45% of domestic seats will be on large mainline aircraft up from 30% in 2018 with the average gauge increasing by around 7% over the next five years.

For the wide body fleet it has outstanding orders for 35 A330neos and 12 A350s. It is in the process of expanding its five-cabin strategy across the entire international fleet by 2021, with the Delta Premium Select product fully rolled out by then. It plans to increase the average number of seats per aircraft by 2% a year over the next five years, and increase the number of premium seats per aircraft by 40%.

The management estimate that this strategy of replacing old generation equipment with larger aircraft will reduce fuel burn per seat by between 20% and 40%, and with the increase in the proportion of premium seats give it a bottom line margin improvement of up to 10 percentage points. 

Unique JV portfolio

Over the last ten years since the merger with Northwest, Delta has built what it regards as a unique portfolio of international joint ventures and airline equity investments. Then, the SkyTeam JV with AirFrance-KLM and Alitalia on the Atlantic accounted for 35% of international revenues. In 2018 60% of Delta’s international revenues were in joint ventures covering the Atlantic, North and South Pacific, and with Mexico.

In 2012 it acquired SIA’s 49% stake in Virgin Atlantic for $360m and gained anti-trust immunity for a full joint venture. And then in 2017, Delta and China Eastern invested $887m in Air France-KLM for a 10% stake each. This allowed Air France-KLM to announce plans to take a 31% stake in Virgin Atlantic (for £220m). The plan to bring Virgin fully into the Atlantic JV — which would represent $13bn turnover and nearly 30% of Atlantic capacity — is still awaiting approval.

But Delta has also built ATI joint ventures with Virgin Australia, Aeroméxico and Korean while investing in Aeroméxico, China Eastern and GOL. Its proposed JV with WestJet has gained approval from the Canadian authorities, but awaits a decision from the US.

The latest move, in June this year, was for Delta to announce it had built a 4.3% stake in Hanjin KAL — the majority shareholder of Korean Air — for an estimated $88m, with possible intentions to increase its investment to 10%. The Korean JV only started last year but Ed Bastian has described it as one of Delta’s “fastest-integrating and most successful partnerships”.

There is not a glorious history when airlines take minority stakes in other airlines. But international cross-holdings must be minority, and the investor cannot be seen to exercise control in order to avoid contravention of rules set down in bilateral air service agreements. It does appear that Delta has been providing influence to the benefit of its partners — possibly at Air France-KLM, and hopefully at troubled Korean.

Meanwhile Delta sometimes appears over-protective of its global “franchise”. It was a founder member of the “Partnership for Open and Fair Skies” (along with American, United and various unions) designed to lobby against the growth of the Gulf carriers — particularly Emirates, Etihad and Qatar — on the basis that the UAE and Qatari carriers were “unfairly” subsidised.

After Qatar took a 49% stake in Air Italy the lobby group intensified efforts claiming that this represents an unfair back-door creation of fifth freedom services and “the latest in a string of trade violations by the government of Qatar”. Delta’s Ed Bastian himself has called it “cheating behaviour” at investor presentations, without recognising the irony of his position as a 49% actual controlling investor in Virgin Atlantic. But then Delta is in discussions with Ferrovie dello Stato to invest in a new and revitalised Alitalia (see Aviation Strategy, May 2019).

Margin expansion

The optimism expressed at the investor day last December and on the full year results call seems to have come true in the first quarter results. Revenues were up by 7.5% to $10.4bn with a 2.4% increase in total revenue per seat "driven by double-digit growth in domestic corporate revenue and around one point benefit from the Ames agreement. Costs grew by 5%, primarily driven by a 5% increase in fuel costs (underlying unit costs excluding fuel fell by 0.2%), generating an adjusted operating profit of $1.03bn — a margin of 10% up from 8.3% in the prior year period. Not bad for an off-season quarter!

In the release Delta also notes that it generated $2bn in cash flow in the quarter despite paying out $1.3bn profit sharing to employees for the performance in 2018. On top of that it accelerated its share buyback programme returning $1.6bn to shareholders in the quarter (of which $233m were in dividends). And it upgraded its outlook for the year ahead. The company no doubt it is keeping everyone happy: customers, employees and shareholders alike.