DAL - Delta Air Lines Stock Q3 Earnings Preview: What To Watch For

2023-10-06 13:25:26 ET

Summary

• Delta Air Lines is set to report third-quarter earnings, which will provide insight into several important factors for long-term investors.
• Analysts expect Delta to report strong numbers for the third quarter, but tough comparisons and declining ticket prices may impact investor sentiment.
• Investors should pay attention to the impact of engine recalls, operating margins, the recovering corporate travel market, supply chain challenges, and the competitive landscape.

When Does Delta Air Lines Report Q3 Earnings?

Delta Air Lines, Inc. ( DAL ) is scheduled to report third-quarter earnings on October 12, and this earnings report will shed light on several important factors for long-term investors. Before the company reported second-quarter earnings, I thought Delta was fairly valued based on its historical valuation levels, and concluded that there was no margin of safety to invest in the company at the time. Since then, DAL stock has shed almost 24% of its value. In July 2022, I rated Delta stock a buy amid the improving outlook for the travel sector when the stock was trading just below $32. I am upgrading Delta stock today ahead of the upcoming earnings report based on the attractive valuation, and I am planning to initiate a new long position.

Tough Comparisons May Take The Center Stage

The global travel demand remains robust as we move into the fourth quarter of this year, and Delta is likely to report strong numbers for the third quarter given the company’s strong footing in both the domestic and international air travel markets. For the third quarter, analysts are expecting EPS of $1.97, a YoY improvement of just over 30%. With pent-up demand for travel showing no signs of slowing down despite inflationary pressures, I will not be surprised if Delta reports better-than-expected revenue growth for the third quarter. An improvement in total available seat miles seems a given at this point, and the market is unlikely to react positively to this development.

Although Delta is likely to report robust growth across all key financial metrics, I believe tough comparisons will eventually take center stage, deteriorating investor sentiment toward the company. According to data from U.S. Inflation Calculator, average air ticket prices have come down dramatically in the last few months compared to the same period last year. For instance, average airline ticket prices fell by 13.3% in August, following a decline of 18.6% in July. Apart from the first three months of the year, ticket prices have fallen in each month so far this year. The increasing overall capacity in the airline sector has a lot to do with these price declines. As a premium airline that enjoys above-average revenue per seat mile, declining ticket prices may limit Delta’s investment appeal in the coming months.

With average crude oil prices rising as much as 30% in the third quarter, fuel cost comparisons are also not skewed in favor of Delta. Continued pressure from OPEC+ to keep crude oil prices elevated through supply cuts may weigh on investor sentiment following Delta’s third-quarter earnings report.

Key Discussions To Look Forward In Delta's Q3 Earnings Report

In September, RTX Corporation ( RTX ) announced that 600-700 Pratt & Whitney engines will be recalled from this year through 2026, leading to an average of 350 aircraft being grounded every year. P&W engines have faced backlash in recent months due to various types of engine failures, including contaminants in the powdered metal used in PW1100G-JM, a geared turbofan used widely in Airbus aircraft. Delta Air Lines has deployed around 100 aircraft with PW1100 engines, which makes it the most impacted North American airline from this negative development. The affected aircraft include Airbus A220 and Airbus A320 aircraft. The impacted aircraft will be grounded at various times as the engines would need to be dismounted to be fixed. Delta, according to Plane Spotters, has a fleet of 964 aircraft today, and the impacted aircraft represent more than 10% of its total fleet.

The fleet of Delta Air Lines

The repairs are likely to take during the off-peak season to avoid a hit on the airline’s capacity, but I believe investors should keep a close eye on new developments on this front to determine any potential impact on Delta’s profitability next year. During the upcoming earnings call next week, Delta’s management is likely to shed more light on this risk and discuss the company’s strategy to mitigate the impact of the grounding of some of its aircraft.

Next, I will pay close attention to the company’s discussion on operating margins. Elevated jet fuel costs are likely to have a negative impact on margins, and I am looking forward to how the company plans to manage its cost base to mitigate this impact. The company has already lowered its forecast for adjusted operating margins in light of rising costs. In addition to jet fuel costs, investors need to evaluate the trajectory of non-fuel costs, including maintenance costs, to gauge a measure of how the company is performing amid inflationary pressures.

Another important data point that I am looking forward to is how Delta was impacted by the recovering corporate travel market in the third quarter. In the second quarter, Delta started seeing some improvements in this key market segment, with many businesses planning to increase corporate travel in the latter half of this year. Before the pandemic, corporate travel played an important role in helping Delta’s earnings growth. As a more efficient, better-managed company in the post-pandemic era, Delta stands to benefit from the rising demand for corporate travel. I believe this could prove to be a catalyst driving Delta’s earnings and stock price higher in 2024.

I am keeping a close eye on how industry-wide supply chain challenges are impacting Delta as well. In particular, my focus will be on aircraft delivery delays and training delays highlighted by Delta in the second quarter. Failure to keep up with the pace of industry transformation may harm Delta’s positioning as a premium airline carrier, which may eventually hurt its future financial performance.

Finally, investors need to evaluate the competitive landscape in the international market to determine Delta’s ability to stay competitive in the long run. The domestic markets recovered faster than international travel after the massive blow dealt by the Covid-19 pandemic. In the recovery phase, many international carriers are fighting for the same customer cohorts, making it difficult for Delta or any other airline to build competitive advantages.

DAL Stock's Valuation Is Becoming Increasingly Attractive

Delta Air Lines is currently valued at a forward P/E of 6, in stark contrast to the 5-year average of 16. Based on historical multiples excluding the abnormalities seen during peak Covid, a more justifiable P/E for delta falls in the range of 10-11 (as explained in my previous article). With the airline industry expected to benefit from favorable demand trends in the foreseeable future, I believe Mr. Market is being too harsh on Delta today. In the next 12 months, I expect Delta’s stock price to benefit from two factors – continued earnings growth and an expansion in earnings multiples. Based on these assumptions, I believe Delta Air Lines stock is very attractively priced today.

Takeaway

Delta Air Lines has not been consistent with exceeding analyst expectations in the last few quarters, with the company beating analyst estimates for earnings in 5 of the last 8 quarters and missing estimates three times. As an investor who closely follows earnings surprises and earnings revisions history to gauge a measure of the momentum behind stocks, this is not a track record that impresses me. Then again, Delta is too cheaply valued to ignore today. I am upgrading Delta stock to buy from hold based on valuation ahead of the upcoming earnings report, while acknowledging the possibility of DAL stock losing more ground in the short run due to cost pressures.

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