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Rising capacity in the airline industry has been a main concern among investors over the past couple of years and based on Delta Air Lines' (DAL) Q2 earnings miss and downside Q3 guidance, it's evident that an oversupply of seats is now putting a squeeze on the industry's margins and profits. As the first major airline to report Q2 earnings, DAL's disappointing results and outlook indicate that more turbulence is likely ahead for the space, especially since DAL's financial performance has generally outpaced its rivals.

• After three consecutive earnings beats, DAL fell just short of Q2 EPS estimates as lower ticket prices and higher operating costs weighed on its bottom line. Like its competitors, DAL has steadily ramped up capacity to meet the insatiable demand for travel, which remained strong in Q2 as revenue reached a June quarter record.
  • Available Seat Miles (ASMs) grew by 8% yr/yr, led by a 19% jump in DAL's Latin America market, helping to drive revenue higher by a little more than 5% to $15.41 bln
• The problem, though, is that consumers -- particularly in the U.S. -- are dialing back on their travel plans, opting for less expensive trips, while industry-wide capacity is at sky-high levels. CEO Ed Bastian acknowledged that the company is seeing some price sensitivity taking hold in the lower fare categories.
  • As such, Passenger Revenue per Available Seat Mile (PRASM) decreased by 3% in Q2.
• Given the steady rise in capacity across the industry, it doesn't come as a major surprise that DAL's PRASM is being pressured a bit. However, what might be catching investors a little more off-guard is the company's commentary and forecast regarding the demand situation. Specifically, CFO Dan Janki stated that "growth continues to normalize", while DAL's Q3 revenue guidance of $14.84-$15.13 bln also missed expectations.
• Demand certainly isn't falling off a cliff and there are still notable areas of strength, including in DAL's premium, corporate, and international businesses. Premium revenue grew by 10% yr/yr, corporate travel demand was up double-digits, and international passenger revenue increased 4%, despite lapping challenging yr/yr comparisons.

Additionally, DAL continues to pay down its debt, thanks to its strong free cash flow generation of $1.3 bln in Q2. By the end of Q2, the company's Adjusted debt to EBITDAR decreased to 2.8x from 3.0x at the end of 2023. The bottom line, though, is that DAL's and its peer's earnings are facing strengthening headwinds due to an unfavorable supply and demand dynamic as consumers begin to tighten their travel spending budgets.