Delta Lands in Trouble Again - TheStreet

Updated from 1:23 p.m. EST

Delta Air Lines

(DAL) - Get Report

fired a bold salvo earlier this year at both traditional network rivals and low-cost upstarts with a sweeping fare restructuring.

But given the airline's already precarious financial position -- combined with oil's recent surge back to near-record highs -- Delta simply may have shot itself in the foot.

The nation's No. 3 airline launched Simplifares in January, touting it as a way to win back customers who flocked to low-cost carriers such as


(LUV) - Get Report



(JBLU) - Get Report

out of frustration with network airlines' more complex fare structures and higher maximum fares.

The program slashed fares by as much as 50% and capped domestic tickets at $499 one-way for economy and $599 one-way for first class. The airline said Simplifares would provide long-term benefits by stimulating traffic but acknowledged it would have an initial negative impact on operating results. With fuel prices on the rise again, it now appears poorly timed.

"When they initiated Simplifares, I don't think they expected oil prices to go back up to $55 a barrel," said Helane Becker, airline analyst at the Benchmark Co., a New York-based brokerage. (Benchmark neither does nor seeks to do business with companies its analysts cover.)

After moderating somewhat from last October's all-time highs above $55 a barrel, crude oil futures have rallied again in recent weeks. On Wednesday, they hit $55.65, just 2 cents shy of the record intraday high.

Delta cited high fuel costs as one of the factors behind the profit and liquidity warning that it gave on Thursday and that sent its shares tumbling.

In its annual 10-K filing with the

Securities and Exchange Commission

, Delta said: "As we transition to a lower cost structure, we continue to face significant challenges due to low passenger mile yields, historically high fuel prices and other cost pressures related to interest expense and pension and related expense. Accordingly, we believe that we will record a substantial net loss in 2005, and that our cash flows from operations will not be sufficient to meet all of our liquidity needs for that period."

Also in the filing, Delta acknowledged its business plan assumes average 2005 jet fuel prices substantially lower than what crude oil futures currently imply. The airline's assumption is for an average of $1.22 a gallon, with each 1-cent increase in the average price increasing the airline's liquidity needs by $25 million a year.

Current oil prices also suggest Delta is paying significantly more than $1.22 a gallon for jet fuel. The airline paid an average of $1.42 a gallon for jet fuel in the fourth quarter, when crude oil hit record highs. With crude again near those levels, Delta's fuel costs are above expectations, noted Brian Hayward, senior equity analyst at Zack's Investment Research.

"If fuel prices stay where they are, they're 20 cents a gallon off what they expected," Hayward said. "With 20/20 hindsight, Simplifares was ill-timed, because I think when they did it, they didn't expect that recent (crude) squeeze." (Hayward owns no stock in companies he covers, and Zack's does no business with companies its analysts cover.)

Delta spokesman Anthony Black said the results of Simplifares had been a "little bit better" than what the airline had anticipated for both unit revenue and traffic. The airline had previously announced that domestic mainline traffic, which excludes smaller, regional flights, was up 6.6% in February, traditionally not a strong month for air travel.

Hayward said estimating the revenue impact of Simplifares is difficult. "The fares they reduced were not necessarily the ones that they would have lost to low-cost carriers," he said. "They were the walkup fares, which tend to be purchased by last-minute business travelers, and I don't know how many of those passengers they had lost to low-cost carriers. If it stimulates enough traffic to stimulate higher revenue, that's good, but I just don't know if it does."



(CAL) - Get Report

, however, has quantified Simplifares' impact to its revenue and it is negative. This week, Continental forecast a $200 million-a-year revenue hit.

"Our experience to date as a result of Delta's fare reduction has demonstrated the fare reductions are not being sufficiently offset by increases in passenger traffic so as to make them revenue positive, and any associated cost reductions are immaterial to date," Continental said in an SEC filing. (On average, analysts expect Continental to bring in $10.20 billion in revenue this year, according to Thomson First Call.)

Gerard Arpey, the CEO of American Airlines' parent



, also has said the industrywide fare reform will dent near-term revenue. Yet, he has contended the effects of fare reform are "complex."

"We think that revenue dilution, while real, will be offset at least in part by share shift, increased traffic and the restructuring of our corporate contracts," he said at a recent J.P. Morgan investor conference. "In fact, in certain markets where significant share loss has already happened, we believe this shift might actually be revenue positive."

Late last year, American Airlines actually simplified its fare structure and reduced fares for Miami in an attempt to lure back passengers who were flying with rivals like JetBlue at nearby airports. Arpey said the move increased domestic unit revenue at Miami by more than 5% year over year in January.

In spite of potential positive results in specific markets, Delta's financial situation may have argued against bold new moves.

The airline staved off filing for Chapter 11 bankruptcy protection last October only by getting pilots to accept wage and benefit cuts valued at $1 billion a year and securing additional financing from

General Electric

(GE) - Get Report


American Express

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, which has a frequent-flyer program with Delta.

In its 10-K, Delta said it now must rely on available cash and short-term investments, a regional jet credit facility and the final $250 million of financing from American Express in order to meet its liquidity needs this year.

Worse yet, Delta said it doesn't expect to be able to supplement its liquidity with fresh debt financing, because almost all of its assets are already encumbered and its credit ratings are low.

Delta spokespersons did not return phone calls in time for this story.