Earnings Season Is Here and It's All Lights Green, According to This Company

Investors often look to Delta Air Lines' (NYSE: DAL) financial reports because they serve as valuable indicators of what they can expect from the upcoming earnings season, particularly in terms of the state of discretionary consumer spending.

The good news is that the latest earnings release for Delta Air Lines, released on Oct. 9, shows the company was in fine shape in its most-recently reported quarter, but what does it mean for the rest of the market? Here's the lowdown.

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Delta Air Lines' third-quarter earnings

Going into the third-quarter earnings report, there were some concerns that the company might report some weakness, particularly in its main cabin operations. After all, budget airline Spirit Airlines filed for Chapter 11 bankruptcy protection in August. Moreover, the conditions that created booking weakness earlier in the year for Delta, namely the uncertainty created by the tariff conflicts, are largely still in place.

The impacts of those issues are likely to be echoed across much of the economy as investors look to airlines as a barometer of overall conditions, not least as ticket bookings tend to occur on a very short cycle.

However, those fears about Delta's business were quickly dispelled by the numbers from the third quarter, management's updated full-year guidance, and commentary on current trading. The takeaways from the earnings report:

• Q3 non-GAAP year-over-year revenue growth of 4.1% exceeded the high end of management's guidance for growth in the 0% to 4% range, and the non-GAAP operating margin of 11.2% also came in above the guidance range of 9% to 11%.
• Non-GAAP earnings per share (EPS) of $1.71 were near the top end of the $1.25 to $1.75 guidance range.
• Premium product ticket revenue increased 9% to $5.8 billion. Although main cabin ticket revenue was down 4% year over year, CEO Ed Bastian said, "Main cabin trends are improving." President Glen Hauenstein also noted that there had been a "main cabin inflection as industry supply moderated and demand improved, materializing earlier than our initial expectations."
• Discussing recent sales, Hauenstein said, "Over the past six weeks, sales trends have accelerated across all geographies and in every advanced purchase window.
• Based in part on the current quarter's trends, management updated its guidance: Full-year EPS is now expected to be approximately $6, in contrast to the range of $5.25 to $6.25 offered previously, and free cash flow is expected to be $3.5 billion to $4 billion, compared to previous guidance of $3 billion to $4 billion.

Premium power

The pattern of Delta's premium product revenue growing by more than its main cabin revenue has been in place for some time, and investing in its premium offerings is a key part of management's plans. It's also one key to the thesis for investing in the stock.

Indeed, as Hauenstein noted, "the best margins are in the most premium products and you just work your way down." In another bullish comment, Bastian said that the rebound since July was "led by a rebound in business travel, which was up high single digits in the quarter."

Current conditions look good for Delta. It has an improving main cabin travel market, which is coming in to add support to its ongoing robust growth in premium spending. Furthermore, corporate travelers have been returning in substantial numbers since the summer.

Image source: Getty Images.

All together, it's easy to see how these results might augur that other companies will report stronger third-quarter consumer discretionary spending as this earnings season progresses, and that business spending will also improve.

However, that conclusion might be a mistake.

This is Delta's strength, not necessarily economic strength

Two arguments support the headline conclusion. First, likely, Delta's slight reduction in the amount of main cabin seating it's making available and its rationalization of capacity have helped temper supply, leading to a more favorable outcome for its main cabin segment. Yet as noted above, budget airlines like Southwest are facing significant financial pressures, and they can't maintain or expand capacity as they did in previous cycles. Moreover, airlines in general are behaving in a much more disciplined manner with regard to capacity these days.

In addition, one must recognize the particular way Delta is achieving its shift toward catering more to higher-spending customers. As Hauenstein explained on the earnings call, "The premiumization, if you will, of the Delta ecosystem is really dependent on two things. One is the [aircraft] retrofits ... which accounts for probably about 25% to 30% of the incremental premium seats, and then new aircraft deliveries that are continuing to come with a higher mix of premium as they roll out of the factory."

Image source: Getty Images.

Second, upon reviewing the SEC filings, management disclosed that the weakness in Atlantic revenue (down 2% in the quarter) and Latin America (down 3%) was due to specific weaknesses in main cabin revenue and "demand for Mexico leisure markets," respectively.

All told, Delta Air Lines' Q3 earnings support the bull case for the company, but it would be a mistake to conclude that they indicate that last quarter was strong generally for mass-market consumer discretionary spending. In other words, buy Delta Air Lines stock on the back of these results, not necessarily the market.

Lee Samaha has no position in any of the stocks mentioned. The Motley Fool recommends Delta Air Lines and Southwest Airlines. The Motley Fool has a disclosure policy.