2023-05-12 13:22:56 ET
Summary
- Delta remains one of the most competitive airlines in the U.S.
- The airline has done well to improve its operations.
- Valuation remains attractive, considering the positive business outlook.
Delta Air Lines ( DAL ) has forecasted that it will deliver record revenue in the June quarter, and expects growth to be around 15% in 2023. Delta has turned around its operations in recent years, after the COVID shock, and now stands as one if not the most preferred airline in the US .
The company was profitable on a non-GAAP basis during the first quarter despite higher operational costs and continues to show strong performance despite the fact that average airline prices rose by 17% during the first quarter. Domestic travel has been growing quicker than analysts had expected, and the theme should continue through the year unless there is a significant downturn in the economy. This means Delta's results should in better than expected. I, therefore, believe the stock should see positive returns.
How is Delta maintaining its competitive advantage?
Efficiency
Delta has continued to invest in its overall experience over the years, including better cabins, and premium services, making it an airline that has separated itself from its rivals. While, the price remains the most important aspect that customers look at, along with the services offered, being on time is also a significant aspect of the whole experience. And Delta has continued to be the most punctual airline, with an 81%, on-time arrival, which has clearly played in its favor .
Beyond improving amenities and services, and being punctual, Delta's network is also a significant advantage.
Network Advantage
Beyond advantages that stem from efficiencies, Delta also has an advantage with its network , which is robust, both domestically and internationally. The hub and spoke system, with a significant amount of flights into America's busiest network, which is Atlanta, allows it to ensure that Delta's flights are available to customers throughout the mainland US. Furthermore, it has significant extension flights to major hubs such as Heathrow, allowing for a connection of not only local flights but international flights as well. The synergy has allowed Delta to compete better, and provide it an advantage over its competitors, who are not as well networked.
Furthermore, Delta continues to improve its network and is adding a number of European routes through 2023 , as it looks to take advantage of the revival of international travel in 2023. This should help the company further improve its revenue, as the cross-Atlantic flights improve the airline's overall yield. Delta's airline yield increased to 20.95 cents during the latest quarter, compared to say Southwest Airlines, which has a yield of 17 cents. The difference can primarily be attributed to Delta's international network, where the overall earnings are better.
Adding to Delta's momentum is the theme of an increasing number of Americans traveling to European countries in 2023. Europe is expected to be a significant source of travel, the combination of higher-value passengers that go to Europe, and continued demand for European routes, means Delta should be able to see improved revenue and efficiency in 2023.
Over the years, Delta has further shored up its operation by improving the overall experience of its flights. By improving interiors and adding premium classes as a larger percentage of its total travel, Delta has managed to improve its growth prospects. And that should only see further improvement with front cabins currently operating at around 70-80% capacity, and with increasing demand, should see the premium cabin load factor converge with the rest of the airline cabins.
Operational Outlook
Load factor still remains slightly low at 83%, most airlines prefer load factor to be closer to 89-90%. Management has indicated that come 2024, the load factor should return to those levels.
Delta Air Lines' margins have been affected by higher costs, but, they should be able to recover in 2023 unless higher oil costs weigh on travel.
Higher oil costs are a major factor in terms of risks, and if the company continues to see higher oil prices, it will have to continue to raise its ticket prices. Higher ticket prices will play a major factor in travel in 2023 and represent a risk to overall travel volume, which in turn could affect the company's revenue, as fewer travelers choose flights. This could be especially a problem for international flights if travelers are choosing to fly primarily for pleasure; as such, travelers would likely cut back on travel.
Financial Outlook
Regardless, Delta's overall valuation remains relatively moderate, with a current P/E around 11x, assuming a 15% growth in revenue, stemming from an increase in domestic travel, and also an increase in international travel. This would mean that, unless we see oil prices come down, the forward P/E will be around 9x. But, if oil prices continue to rise, and operational costs increase, the net income could stay around 11x, and furthermore, if a recession comes on stronger than expected revenue growth could slow to single digits, and potentially even stay stagnant.
Risks stemming from a recession are not likely till late 2023, or 2024, as the labor markets remain strong, and therefore, there isn't a lot of revenue risk currently stemming from a cutback on travel, at least in the short term. So, over the next few quarters, results should remain steady. Similarly, oil prices also remain steady for now, but, with demand likely to outstrip supply soon, oil prices could be heading up, which could lead to the bottom line coming in weaker than expected.
Beyond operational risks, an important risk is the large debt load, with $30 billion on the books, interest rate risk remains an issue for the company. Delta's cash flow from continuing, which currently stands at around $6 billion, faces the twin headwinds of rising costs, stemming from inflation and commodity prices, and interest rates.
Furthermore, Delta's capital expenditure and investing activities have had a significant effect on the company's cash flow in 2022 and could continue to weigh on the company's cash flow in 2023 as well. Should the high expenditure rate continue into 2023, the combination of factors could lead to Delta facing adverse events related to valuation.
Overall, Delta's prospects remain quite strong, over the medium term. Should the next few results come in better than the market expects, then there could be a case for the stock to rise by about 20-25%, in the medium term, as valuations come in line with the broader market. Investors could look at building a position but may wish to back off later this year, as 2024 has significant risks associated with a slowdown.
For further details see:
Delta Air Lines: A Relatively Bright Future