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Delta Air Lines(DAL - Analyst Report) - the second largest airline company in U.S. after United Continental Holdings, Inc. (UAL - Analyst Report) reported third-quarter 2012 adjusted earnings of 90 cents. The quarter’s earnings were a penny behind the Zacks Consensus Estimate.

Adjusted net income excludes $440 million of fuel hedging gains, $39 million gain related to exchange of slots, $66 million loss attributable to severance costs, $12 million expense regarding write-off of debt and $122 million of cost related to other streamlining actions. Including these charges, Delta reported a gain of $1.23 per share in contrast to earnings of $0.65 per share in the year-ago quarter. Such improvement was mainly attributable to falling fuel prices, fare hikes and the ongoing cost-cutting measures.

Revenue

Revenue edged up 1% year over year to $9.92 billion in the reported quarter but fell marginally short of the Zacks Consensus Estimate of $9.98 billion. On an annualized basis, Passenger revenue grew 1%, while Other revenue remained nearly at par with the last-year quarter. However, Cargo revenue dipped 5%.

Airlines traffic, measured in billions of revenue passenger miles, remained almost flat year over year. Capacity or available seat miles fell 12% while load factor (percentage of seats filled with passengers) grew 30 basis points year over year to 86.4%. Passenger revenue per available seat mile (PRASM) or unit revenue rose 3% year over year, led by a 3% increase in yield.

Operating Expenses

Total operating expenses, including special items, fell 4% year over year, primarily due to drop in aircraft fuel and related taxes.

Consolidated unit cost or cost per available seat mile (CASM), excluding fuel cost, profit sharing and special items, crept up 5.6% and CASM, including fuel expenses, profit sharing and special items, dipped 2% year over year in the reported quarter.

Liquidity

Delta Air Lines’ balance sheet continues to be strong. At the end of September 2012, the company had $5.1 billion in unrestricted liquidity including $3.2 billion in cash and short-term investments, and $1.9 billion in undrawn revolving credit facilities.

The company reduced its adjusted net debt to $11.9 billion from $12.1 billion at the end of the prior quarter. Delta has attained approximately $5 billion of debt reduction over the past two years.

The company generated operating cash flow of $545 million in the reported quarter while capital expenditures were $425 million.

Guidance

For the fourth quarter, Delta Air Lines expects operating margin in the range of 4–6% and consolidated unit cost, excluding fuel and profit sharing, to grow 5–7% year over year. Additionally, the company expects domestic flying to decrease 1–3% year over year and international flying to decrease 2–4% year over year.

The estimated fuel price, including taxes and hedges, is approximately in between $3.15 and $3.20 per gallon and total liquidity is projected at $5.2 billion with capital expenditures of $450–$550 million.

Our Take

We are maintaining our long-term Underperform recommendation on Delta Air Lines. For the short term, the company retains Zacks # 3 (Hold) Rank.

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