Delta Airlines (DAL  ) shares finished higher after initially opening lower, following the company's weaker than expected Q2 earnings. Delta's earnings were highly anticipated by investors for clues on how the travel sector was performing amid a worsening economic environment. Airlines are seeing higher volumes but are struggling to increase capacity and facing higher costs across the board, most notably for fuel and labor.

Overall, Delta is down 24% YTD which is in line with the broader market, however, the bulk of these losses came about in the last six weeks, as recession risks increased. Currently, the market sees revenues and earnings being impacted by the economic slowdown, yet real-time data continues to show increasing and resilient travel demand.

Of course, this conflict between market-based forecasts and the company's bookings will pose another challenge. Normally, airlines want to reduce capacity in a recession, but this environment may be different due to the pent-up demand for all types of travel.

Inside the Numbers

In Q2, Delta Airlines reported adjusted earnings per share of $1.44 which was better than expectations of $1.73 per share. Revenue topped expectations at $13.82 billion versus $13.57 billion, a 33% increase from last year's Q2.

Compared to 2019, the cost per mile was up 22% not including fuel. Fuel costs were 41% higher compared to 2019, an additional $3.2 billion expense.

Overall, demand for business and leisure travel was strong. Domestic business travel is back to 80% of pre-coronavirus levels and 25% up from last quarter.

The big picture is that costs were up but demand and pricing power was strong enough to offset this. It's also focusing on reliability due to an increase in delays and cancellations which is exacerbated by a tight labor market. Currently, the company is no longer looking to increase capacity. It's at around 84% of the 2019 level and is focused on training new staff.

Next quarter, it sees sales growth between 1% and 5% while costs continue to rise. Despite these pressures, it sees itself profitable in Q3 and for the full year.

Delta's earnings make it clear that most investors are focused on the company's costs as this is the biggest challenge. Demand and pricing power remain strong, and it's clear that inflation is going to recede. The bear case is that demand and pricing power deteriorate more than inflation, while the bull case is that they remain strong due to underlying fundamentals, leading to bigger margins and fatter profits for the airlines.