RTX - Delta Air Lines: Why The Steep Plunge Should Excite Buyers Now

2023-09-21 16:00:25 ET

Summary

• Delta Air Lines stock has significantly outperformed the S&P 500 since my Buy rating in July 2022 as Delta sentiment reached peak pessimism.
• However, Delta fell into a bear market recently as it topped out after its second-quarter earnings release. It likely stunned the Bulls, even as Delta posted a robust scorecard.
• With the steep plunge from its July highs, I assessed that Delta Air Lines could be on the verge of bottoming out despite near-term headwinds.
• Investors are likely worried about the Pratt & Whitney engine issues and the surge of oil prices impacting its earnings recovery.
• I make the case for why these headwinds are likely priced into its valuation, as Delta looks well-primed to recover its uptrend bias. It's time for Delta buyers to be greedy.

I last updated Delta Air Lines, Inc. ( DAL ) investors in July 2022, urging them to buy, as I anticipated peak pessimism. To be clear, DAL didn't bottom out until October 2022. However, it formed another bear trap (false downside breakdown), corroborating its robust July support zone ($27 level).

As such, I'm not surprised that DAL has significantly outperformed the S&P 500 (SP500) since my previous update, notwithstanding its recent bear market.

Yes, you read it correctly. DAL buyers who bought into its mid-July 2023 highs have suffered a great deal, as it topped out in mid-July ($50 level) after forming a well-disguised bull trap (false upside breakout). Ring a bell? Recall that Delta Air Lines reported its second-quarter or FQ2 earnings release on July 13, suggesting investors rapidly baked in optimism as DAL surged toward the week of its earnings call.

Following the bull trap, DAL has plunged nearly 23% through this week's lows, revisiting levels last seen in early June, likely spooking investors who chased DAL's early summer upward spike to flee. However, it also serves as a timely reminder and caution about chasing upward momentum at untimely levels as DAL reached peak optimism.

And what a time to be a seller at DAL's July highs, as the sellers timed it to near perfection. Delta's engine supplier RTX Corporation ( RTX ) first unveiled toward the end of July that it faced challenges with manufacturing quality on its Pratt & Whitney GTF engines, leading to a sharp decline in its shares. It then updated in early September that it anticipates a marked hit on its FY25 free cash flow or FCF guidance after a closer assessment following its initial July update.

As such, the market is likely pricing in heightened execution risks on Delta's fleet capacity growth over the next few years. Management's commentary at a recent mid-September conference suggests Delta was not ready to commit to providing a guidance update, as the company is still "in the early stages of assessing the situation related to RTX's GTF engine issues." As such, the company needs more time to ascertain the "secondary impacts and potential supply chain effects."

Furthermore, Delta downgraded guidance for its Q3 adjusted EPS. However, it provided an upbeat assessment of its revenue growth, anticipating it to be in the "upper half of its previous guidance range," between 11% and 14%. Despite that, management revised its adjusted EPS guidance range downward to between $1.85 and $2.05, markedly below its previous outlook of $2.20 to $2.50.

Delta attributed the downward revision to less favorable fuel and non-fuel costs. I believe the de-rating makes sense, as underlying Brent crude oil futures ( CO1:COM ) have surged since its June 2023 lows ($70 level), reaching nearly $96 this week (up more than 37%). As such, the surge in oil prices has likely blindsided the market, although it didn't surprise me.

I have already anticipated that the energy sector ( XLE ) was bottoming since March, as I upgraded the sector bias to bullish, following the resolution of my initial bearish call in December 2022. Notwithstanding the recent surge, I assessed that crude oil futures seem ready to consolidate, helping to relieve further pressure on Delta Air Lines and its peers. As such, I believe the headwinds on its second-half performance have likely been reflected and are not expected to be much worse from here.

DAL remains attractively priced relative to its sector peers, assigned a "B+" valuation grade by Seeking Alpha Quant. In addition, the company is well-poised to capitalize on the robust rebound in domestic and international air travel, potentially lifting its EPS growth further to pre-pandemic levels in FY24. Accordingly, analysts' estimates suggest an adjusted EPS CAGR of more than 16% from FY23-25. Further bolstered by Delta Air Lines' confidence as it maintained its FY23 adjusted EPS guidance of $6.5 at the midpoint, it should help DAL stabilize after reaching near-term selling exhaustion.

As seen above, DAL fell into a bear market from its July highs, topping out after its FQ2 earnings scorecard, likely stunning the Bulls. Although the company posted a solid card, the market still pummeled DAL over the next two months.

There aren't any possible bear trap levels (false downside breakdown) at the current zone, which could attract potentially robust dip-buying support. However, DAL's 50-week moving average or MA (blue line) could proffer investors an opportunity to assess whether DAL's nascent uptrend bias could still be defended.

More conservative investors can await more favorable price action against its 50-week MA before returning. However, I am convinced that DAL should remain firmly supported, given its improving fundamentals, attractive valuation, and a resolved bull trap as it fell into a bear market.

Rating: Maintain Buy.

Important note: Investors are reminded to do their due diligence and not rely on the information provided as financial advice. Please always apply independent thinking and note that the rating is not intended to time a specific entry/exit at the point of writing unless otherwise specified.

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