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Delta Foresees Healthy 3Q

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The second largest U.S. airline Delta Air Lines Inc. (DAL - Free Report) expects third quarter profits to be solid despite the rising fuel prices and uncertain economic growth.

The company expects corporate bookings to climb 9% year over year despite the capacity reduction of 1-3% in the third quarter. Passenger unit revenue (or passenger revenue per available seat miles) is expected to grow 3-4% year over year thanks to the growing business travel demand and flight expansion in the New York market. The additions of new features to its services as well as introduction of new products are also expected to boost revenue.

Delta expects operating margin in the range of 9–11%, down from the previous expectation of 10-12%. Consolidated unit cost, excluding fuel, is still estimated to grow 3-4% year over year. The company now estimates fuel price to be $3.23 per gallon for the ongoing quarter, up from the previous forecast of $3.09 per gallon.

Delta is leading the industry in managing fuel cost through fare hikes and capacity cuts. Hedging strategies are also the effective tool undertaken by Delta to combat fuel prices. To cut the fuel costs further, the company has become the first carrier to enter into the fuel business by acquiring Trainer refinery in Pennsylvania.

Though the refinery will incur a modest loss in the third quarter, it will start generating profits from the fourth quarter. The oil refinery will likely save $300 million in fuel costs annually. In order to generate more savings, Delta is looking to buy cheaper Bakken crude from North Dakota to feed its refinery at an equivalent or lower price than that of West Texas Intermediate. Currently, the refinery uses crude from the North Atlantic.

The Zacks Consensus Estimate for Delta remains unchanged at $1.00 over the last 7 days, but it fell eight cents in the last 30 days for the third quarter. The estimate represents a significant growth of 9.34% from the year-ago quarter.

Further, Delta Air Lines, which competes strongly with United Continental Holdings Inc. (UAL - Free Report) and Southwest Airlines Co. (LUV - Free Report) , continues to have a healthy balance sheet. The company expects to reduce $10 billion in net debts by the end of the next year and has already achieved $5 billion reduction in last two years. The company expects to exit the third quarter with $5 billion in unrestricted liquidity.

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

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