For the CFO of a large international airline, weather, economic volatility, fuel costs, and world events like terrorist attacks, civil strife, and spreading viruses are among the many unpredictable factors that can play havoc with travel volume and, hence, financial forecasts and results.
That uncertainty, as well as the exorbitant costs for labor, capital equipment, and aircraft maintenance, combined to keep the industry in an almost perpetual financial funk for decades. Profits were fleeting and losses were heavy. Analysts never offered investors much hope that any upturn would be sustainable — although there were always investors, lured by the industry’s romance and excitement.
That’s precisely what enticed Paul Jacobson, the current finance chief at Delta Air Lines, one of three U.S.-based global mega-carriers, to pursue an airline career. He decided at age seven, after taking his first flight, that he would be a pilot. That remained his goal until, set to enter Air Force ROTC pilot training while enrolled at Auburn University, he was medically disqualified because he’d had childhood asthma.
Lacking the financial wherewithal to pay for training on his own, Jacobson pursued a degree in aviation management from Auburn, which he received in 1994. He briefly worked for aircraft manufacturer McDonnell Douglas before heading to Vanderbilt University for an MBA.
“Before classes even started I sat down with my placement director, who asked what I hoped to get out of business school,” Jacobson recalls. “I said I wanted to get a job with an airline, preferably Delta. I’m not exaggerating when I say that he spent the next two years trying to talk me out of it. He said airlines were a terrible business, and they didn’t value MBA talent.”
Apparently not. The year he completed his MBA and landed a financial analyst position at Delta, 1997, Vanderbilt’s graduate business school published two class members’ starting salaries — one of them Jacobson’s. “They published the high and the low,” he laughs. “Guess which one I was.”
He was undeterred, and is glad today that he was. “Every day since then has been a labor of love. I love this industry, and I knew it had a lot of potential.”
But, Jacobson adds, “I never dreamed it could be this good.” That’s not just another expression of his passion for the airline industry, but rather a statement about its recent reversal of fortunes.
Delta, American, and United, the three global U.S. airlines left remaining after a round of mega-mergers between 2008 and 2013, have reaped huge benefits from their scale. In particular, heightened cash flows have enabled them to invest more for the long term than they’d done in the past, providing stability to businesses that had often been close to (and sometimes were in) bankruptcy. They also gained greater flexibility to surgically expand or contract capacity route by route as dictated by demand trends, resulting in lower costs and full planes, and they’ve made a bundle charging passengers for previously free services.
And all that was before fuel prices began to plummet. While that trend created some initial hedging losses for airlines — Delta took a $1.2 billion write-down for that in the fourth quarter of 2014 — by the end of 2015 a full-on bonanza was under way.
Delta, for example, reaped $5.9 billion in pre-tax profit last year, the company announced in its Jan. 19 earnings call. That was 29% more than the 2014 figure — even though revenue nudged up by less than 1%. The difference was attributable to the much lower cost of fuel, which saved Delta $2.8 billion, meaning that it paid 65% less than it had in 2014. Meanwhile, the fourth-quarter write-down for fuel hedging was only $54 million.
The windfall might be even greater in 2016. While fuel costs are notoriously difficult to predict, Delta estimates that they will be down an additional $3 billion this year, Jacobson says.
The entire airline industry has benefitted, but Delta is doing well from a competitive standpoint. For example, the company’s 2015 performance in revenue per available seat mile — a revered metric in the airline industry — was on average 14% better than that of other U.S. airlines domestically, and 8% better than the same airlines across their global networks, Delta CEO Richard Anderson noted in the earnings call.
Big winners from the financial boon are not only Delta and its shareholders (its stock price shot up from a low of $30.54 on Oct. 13, 2014, to finish 2015 at $50.69, a gain of 66%). The airline’s employees are also enjoying the flush times.
In an astonishing example of largesse from a corporate employer, Delta gave all employees other than its unionized pilots and upper management a 14.5% base pay raise on Dec. 1. That was on top of a 3% hike in April of last year. And this month, Delta will distribute $1.5 billion in profit sharing to employees — equal to 21.4% of their wages.
Jacobson, who was promoted to finance chief in 2012, recently spoke with CFO about these and other matters. An edited transcript of the conversation follows.
What is unique about being the CFO of an airline?
The business is inherently unique from others. Every industry has its challenges, but when you look at the global reaches of the big U.S. airlines today, we have a very diversified portfolio across the globe. At the same time we sell a perishable product — as soon as the plane leaves the gate, our opportunity to sell a seat on it is gone.
When you combine those two things, we have to be able to change rapidly in response to events like the Paris attacks and the Zika virus [by reducing or redeploying capacity in accordance with shifts in travel demand]. We have to be nimble.
What does “nimble” mean, in practical terms?
It starts with discipline. This industry historically has been very highly levered. After we completed our integration with Northwest [Airlines] in 2009, we started a process of improving the health of the balance sheet and shoring up our resources. Since then we’ve paid down over $10 billion of debt, which has reduced our interest expense by almost a billion dollars a year.
The second thing we have to do, every single day, is be in a position where we can react to changing market conditions. [CEO] Richard Anderson is fond of saying that a plane is like a hotel, except if a local market is down we can pick up our hotel and move it somewhere else.
Now, there are pros and cons attached to that, because [the other airlines] can do that too, which makes the business inherently competitive. We just have to make sure we’re investing in things that will drive sustainable operational performance and financial wherewithal.
But hasn’t consolidation made the industry quite a bit less competitive than it used to be?
I wouldn’t say that at all. The airlines are bigger for sure, but if you look at the pricing dynamics, all the evidence is there that it’s still very competitive. The industry’s unit revenues were down for most of 2015, and most analysts are saying [that will continue] at least through the middle of this year.
The competitiveness has changed a bit. It’s not just about price. Price is still a very important piece, but we’ve really competed across value chains. Where you see Delta really changing things is with operational reliability, customer service, product amenities, etc. So the competition becomes much more far-reaching.
I really want to ask about Delta’s employee compensation. Do you appreciate how rare it is for employees to get the kind of financial boost that yours have gotten recently?
We recognize that. Delta is filled with people who care deeply about the company and serving our customers. And I don’t think it’s any coincidence that [there is a correlation between] our operational performance and customer satisfaction versus our competitors, and the profit sharing and overall compensation [with which] we reward our employees.
But isn’t the profitability that drove the pay raises and high profit sharing transitory? No one can expect fuel costs to keep falling or remain at historically low levels forever.
Low fuel prices are a big component of it, but at the same time we have to make sure that we continue to drive the business for margins. Our year-over-year fuel-expense [forecast] is a snapshot in time. The reality is that we sell tickets up to a year in advance, and we really don’t have a clear view of fuel costs more than a couple weeks out.
We have to be careful not to get complacent because we got a little bit of benefit on fuel. We have to remain disciplined and stay focused on cost management and driving a superior product, leading to better revenue performance.
The International Air Transport Association recently released a survey of airline CFOs, concluding that their profit expectations have “moderated” for 2016.
I think that’s right. Airlines’ revenue performance was a bit disappointing in 2015 versus expectations heading into the year. For the industry it could have been better. But when you sit in my seat and have a healthy respect for the history of the airline business, it’s performing really well right now.
There’s some concern at the moment that the economy could crash. Is there anything you can do to mitigate the impact of a potential steep falloff in travel volume?
It goes back to what I said earlier about global events and uncertainty. We have to be prepared for that next storm. The real key is shoring up our balance sheet, funding our pension plans [beyond minimum required funding levels], and being disciplined with capital expenditures and costs.
Then if something happens, we have a much better foundation to change the business according to the differing economic landscapes. We’ve been able to do that pretty well through our diversified portfolio.
In the past, because of the weaker foundation, that had been done by taking things away — taking amenities away from customers, taking [job] security away from employees. That type of whipsaw effect doesn’t drive any sustainability at all, and it’s honestly part of the reason why airline economics had been given such a bad rap for so long.
If we’re going to change that, every time we make a product improvement or an investment in the operation, we have to commit to its sustainability. If we’re going to put a product on board our airplanes, it has to be a commitment that we’re making to customers. If we provide a benefit to our employees, it has to be a commitment that we’re making to the employees.
In your earnings call, your CEO said he thinks Delta will achieve an investment-grade credit rating this year. Right now, the only U.S.-based airlines that have that are Southwest and Alaska, which aren’t global carriers. How much would that rating mean?
A credit rating is a testament from the rating agencies about balance-sheet quality and the company’s stability. It will help us in all aspects of the business where credit is involved.
But I think more importantly, it’s a sign of our differentiation. We’ve been focused on getting to an investment-grade balance sheet, whether we got the rating or not, since 2009. Paying down debt and proactively funding our pension plans has gone a long way to improving our credit quality.