2023-07-07 13:00:30 ET
Summary
- Delta Air Lines is scheduled to report second-quarter earnings on July 13 before the market bell.
- The demand environment for air travel is improving, which is evident from recent survey results and TSA data.
- Investors will have to focus on a few key areas in Delta's upcoming earnings report.
The airline industry has come a long way from pandemic lows, and the market has not been oblivious to this stellar recovery. The market values of major American airline companies have trended higher in the last 12 months, with the travel industry continuing to benefit from pent-up demand despite macroeconomic challenges facing the broad economy.
Delta Air Lines, Inc. ( DAL ), one of the leading airlines in the U.S., has been a big winner of the travel industry’s comeback. DAL stock has risen 60% in the last 12 months, aided by the improving outlook for the global travel industry and the resilience of consumers in the face of inflationary pressures.
Almost a year ago, after digesting Q2 2022 earnings, I thought investors should pull the trigger and invest in Delta despite a mixed earnings report that was not well received by the market. Delta stock has delivered handsome gains of close to 50% since then, and the time seems right to revisit the thesis to determine whether Delta is worth holding on to as the company’s second-quarter earnings report approaches.
The Demand Environment Continues To Improve
Leading up to the Independence Day weekend, the Transportation Security Administration projected to screen a record 17.7 million passengers between June 29 and July 5. According to the latest numbers published by TSA, 17.53 million passengers were cleared through its security checkpoints in the week ended July 5, suggesting that initial projections were accurate. Given that this is one of the busiest periods for air travel every year, an evaluation of TSA checkpoint numbers across the last few years will help investors understand the current state of the air travel sector. TSA data reveals that the demand for air travel has fully recovered to pre-pandemic levels today.
Exhibit 1: TSA checkpoint numbers
Several consumer surveys in recent months have conclusively shown that many Americans are prioritizing travel in the post-pandemic era despite inflationary pressures and recession risks. Under normal circumstances, it would have been reasonable to expect travel demand to slow down this year amid uncertain macroeconomic conditions including the increasing risk of job loss. Surprisingly, that has not been the case so far, which comes down to several reasons including a desire to catch up with lost travel plans in 2020 and 2021, the increasing flexibility offered by employers to work while traveling, and the booming popularity of prioritizing experiences over material goods. A Forbes Advisor survey conducted in June found that nearly half of Americans are planning to travel more in 2023, while 38% of respondents expect to travel in 2023 as much as they did in 2022.
Exhibit 2: Forbes Advisor survey results
Digging deeper into these survey results reveals Americans are not just ambitious about traveling more this year but are making strategic decisions to allow them to travel more. For instance, 45% of survey respondents plan to increase their travel budget this year to account for high inflation, while others are taking different measures such as traveling during the off-season, traveling to cheaper destinations, and staying at inexpensive hotels to combat inflation while still going ahead with their travel plans.
The healthy travel demand will create strong demand for major airlines, including Delta. IATA’s data for May highlights how passenger load factors have improved in every region except Latin America compared to May 2022. North America region reported the highest load factor, with Europe closely following.
Exhibit 3: Passenger load factors in May by region
Based on expectations for continued strong demand for air travel, load factors will continue to improve as the year progresses. The demand environment for air travel supports revenue growth for Delta in the coming quarters.
In the upcoming earnings release ( expected pre-market on July 13), I will look for management commentary that adds color to how Delta is benefiting from this favorable demand environment. I believe investors would welcome a discussion on the demand trends for certain market segments, especially for the corporate travel segment, as I believe a notable recovery in business travel is the catalyst that could drive Delta stock price meaningfully higher from here.
Keeping An Eye On Delta Air Lines' Costs
I am keeping a close eye on the cost structure of Delta, as managing costs will play a crucial role in determining Delta’s ongoing profitability. It is no secret that airline companies had to raise capital aggressively to survive the onslaught of the pandemic a couple of years ago, which raised the debt levels of the airline industry. Today, most airline companies are grappling with a debt burden, which makes it even more important for these companies to manage their cost base efficiently. Delta, as a company with long-term debt of close to $19 billion (long-term debt stood at $8 billion in 2019), needs to achieve cost efficiencies to remain well liquidated in future crises to avoid dealing another blow to its financial health.
Delta, in the first quarter, reported a 4.78% YoY increase in non-fuel costs. The upcoming earnings report will reveal whether this trend continued in the second quarter or changed favorably. On a broad level, U.S. airline companies have been forced to pay higher salaries to retain and attract pilots and other staff in the last few quarters, exerting pressure on operating margins. As illustrated below, salaries and wages per available seat mile have increased sharply from Q1 2020 to Q1 2023, and with inflationary pressures continuing to persist, this trend is likely to continue in the second half of this year as well.
Exhibit 4: Salaries and wages per ASM (North American Airlines)
With Delta’s earnings around the corner, I believe investors should pay attention to management commentary on salary trends to gauge a measure of the company’s ability to enjoy higher operating profit margins in the coming quarters.
Fuel expenditure is likely to head lower this year, which is an encouraging sign. According to the latest IATA data , jet fuel cost in North America averaged $98.32 per barrel in the week ended June 30, which is a notable 32% decrease compared to the same period last year. As illustrated below, global jet fuel prices have steadily declined since the beginning of this year.
Exhibit 5: Jet fuel price index
Delta’s cost base will notably improve with a decline in jet fuel costs. The management is likely to shed more color on fuel costs and hedging activities in the upcoming earnings call.
Thoughts On DAL Stock Valuation
As a growth investor, I prefer to use cash flow models to estimate the intrinsic value of companies in my coverage. However, as I recently highlighted to members of Beat Billions, historical P/E ratios can and will give valuable insights into the valuation level of a company at any given time. It is perfectly possible for a company to see a permanent change in its valuation levels, but I like to believe that there is a normal range of valuation for every company which is unique to them. Today, Delta Air Lines seems to be detached from its historical average P/E multiples – which can be either good or bad depending on how you interpret it. For better comparability, I did not include P/E ratios from 2020 and 2021 in my study to eliminate the impact of pandemic-related disruptions.
Table 1: Average P/E ratios ((TTM)) for Delta Air Lines
Year | Average P/E |
2013 | 11.40 |
2014 | 4.28 |
2015 | 14.32 |
2016 | 7.96 |
2017 | 11.20 |
2018 | 9.80 |
2019 | 8.26 |
Source: Morningstar.
Today, Delta is valued at a TTM P/E of 16, which indicates a divergence from its recent past. That being said, Delta is on a path to recovery, and its earnings are likely to climb faster from here compared to the last 12 months. The forward P/E ratio of 9 explains this.
Going by the market reaction to Delta’s most recent earnings, a major stock price move seems unlikely when the company reports Q2 earnings.
Exhibit 6: Earnings-related price changes for DAL
However, I believe a bigger move is probable this time around, given that Delta might boost its projections for full-year profitability. For context, in early June, the IATA boosted its profit forecast for global airlines from $4.7 billion to $9.8 billion.
Takeaway
Delta Air Lines is scheduled to report second-quarter earnings on July 13 before the market bell. I believe investors should focus on a few key areas such as the improving macroeconomic outlook for the airline industry, recent travel trends, and the changes to the company’s cost structure. From a historical valuation perspective, Delta does not seem expensively valued, but the company is not cheaply valued either. Although there is no reason for an investor to book their profits just yet, I believe a better margin of safety is required to take a new position in Delta Air Lines, Inc. stock today.
For further details see:
Delta Air Lines Stock Q2 Earnings Preview: Key Areas To Focus