2023-08-02 15:38:12 ET
Summary
- CPI data indicates lower airfare pricing, potentially due to slowing future travel demand.
- Spending trends, including in the airline industry, are seeing signs of moderation.
- Oil prices are on the rise with an expectation for this trend to continue into the end of 2023 creating a macroeconomic headwind.
Introduction
The travel industry has roared back from the depths of the pandemic-driven disaster. Demands for air travel, both domestic and international, have accelerated as the demand for travel recovered and continued to stay at elevated levels. For this reason, I have been extremely bullish on Delta Air Lines ( DAL ). In my previous article, I pointed out the acceleration of travel demand going into the busy summer months creating an incredibly beneficial environment for Delta Air Lines. Further, considering the future potential from a buoyant demand, I thought Delta Air Lines was trading at an attractive valuation. While the travel demand has accelerated and continues to stay at an elevated level increasing the stock price by 31%, I am not bullish on the company anymore. Many data points pointing toward moderating travel demand have started to arise, which could easily lead to a deceleration in demand in times of economic slowdown. Therefore, considering that the company's valuation likely accounts for a continued elevated demand throughout 2023, Delta Air Lines' stock could have already peaked. For this reason, I am downgrading Delta Air Lines' rating from a strong buy to a hold
Concerning Future Prospects
Future prospects for Delta Air Lines have been bright going into the summer months; however, as we are heading toward the end of the busy season, the demand for air travel is starting to show signs of weakness.
Consumer price index, CPI , data released by the Bureau of Labor Statistics shows that airline fares are decreasing at a rather alarming rate. From March to April, the fares declined 2.6% while the fares declined 3.0% from April to May before accelerating to an 8.1% decline from May to June. Even when compared to June data from 2022, the fares have declined by 18.9% showing a significant weakness in the airlines' pricing power. Thus, I believe it is reasonable to argue that the slowing or moderating consumer demand is pushing prices lower.
Further, data released by Bank of America ( BAC ) also points to a potentially moderating or declining traveler demand. In early May , Bank of America pointed out that consumer spending on airlines has been decelerating saying that the "spending on airlines dropping by 4.5 percentage points to +0.9% YoY in April." Then, in early June , the company's data continued to report stagnating airline spending followed by similar data in early July . As Bank of America puts it, the consumers, especially renters, are "spending down but not out."
Consumers are likely not giving up travel, but instead, they may not be willing to go out of their way to travel as they have for the past year. CPI data shows that air fares are declining followed by Bank of America's data showing that growth in airfare spending has likely ended. Therefore, I believe that these new market environments will have a profound impact on Delta Air Lines. The company will no longer enjoy an extremely favorable travel demand.
Macroeconomic Headwind
Another point of concern for Delta Air Lines going forward is oil prices as it plays a profound effect on the company's bottom line. In the most recent quarter, 2023Q2 , Delta Airlines paid about $2.5 billion in aircraft fuel expenses, which was about $707 million lower than the previous year. The difference in oil expenditure was the primary driver of about a $972 million improvement in the company's operating income. As such, if the oil prices are no long in the ranges of the previous ~$60-$70, Delta Airlines will feel the pinch.
Unfortunately, for the past month, oil prices have been increasing , and I think it is likely that this trend to continue throughout the year as the market is expected to experience a supply deficit due to strong demand and OPEC's intent to limit supply . Saudi Arabia has announced t hat the nation will "extend July's cut of 1 million barrels per day through August" bringing the nation's production to 9 million barrels per day, which is accompanied by Russia's move to cut production by 500,000 barrels per day starting in August. These voluntary actions come on top of continued limitations in supply throughout 2023 as OPEC has continued to announce supply limitations.
While major oil suppliers are limiting supplies, the global demand for oil is expected to be strong. Goldman Sachs ( GS ) is expecting the global oil demand to reach "an all-time high of 102.8 million barrels per day in July." The firm estimates that the resilient demand will lead to a 1.8 million barrels per day deficit for the remainder of the year followed by a 0.6 million barrels per day in 2024.
Overall, Delta Air Lines may face hurdles from rising oil prices as it will likely have a profound impact on the company's bottom line. Suppliers are intent on limiting supplies while the demand continues to be resilient. I believe it is reasonable to expect a headwind for Delta Airlines in the coming few quarters.
Risk to Thesis
Despite signs of a changing demand environment for Delta Air Lines, I did not see a strong enough reason to give the company a sell rating.
First, my view on the company's valuation still stands. In my previous article, I mentioned that Delta Air Lines' valuation is attractive as it trades below the company's historical average of about 10 PE, which still stands today.
Second, the majority of the demand concerns are coming from domestic air travel. Delta is a full-service carrier with a vast international footprint. In fact, about 32.6% of the company's revenue is derived from international travel, which is also growing significantly faster than domestic travel. As such, Delta Air Lines may be fairly insulated from the potential macroeconomic headwinds.
Finally, the airline's management team continues to be confident in the company's future. Looking at the 2023 Q2 earnings call , it is evident that the management team does not see a significant headwind emerging in the near future. They have said that the company is "raising [the] full-year outlook" given the visibility into the rest of 2023. Although the management team does not always have the crystal ball, I believe the management team's view should not be taken lightly.
Summary
Delta Air Lines has enjoyed an elevated travel demand for the past few quarters; however, the prospects regarding future travel demand are starting to show signs of moderation or a slowdown. As my main bullish thesis for the past few months regarding Delta Airlines has been the accelerating travel demand, one of my main reasons for being bullish on the company has dissipated. Further, oil prices have started to rise again with an expectation to gain steam going into the end of 2023 potentially creating further headwinds for Delta Air Lines. Therefore, I am downgrading my rating on the company from a strong buy to a hold.
For further details see:
Delta Air Lines: Headwinds Are Taking Shape (Rating Downgrade)