2023-08-15 16:29:42 ET
Summary
- Delta Air Lines is the best performing major airliner in the US, with a 145.16% increase in the last decade.
- Delta has struggled recently due to increasing oil prices and inflation, but its core business is improving as air travel rebounds.
- Delta's second quarter earnings were strong, with record revenue and profitability levels, and the company raised its guidance for 2023.
Premium doesn't often trade at a discount when it comes to investing. The best run and performing corporations usually command higher valuations, and investors are often forced to pay up for investments in the best companies and top management teams.
Despite being an unpopular sector for many investors, the airline industry has been one of the best performing sectors in the market. I think the best run major carrier in the airline industry is Delta Air Lines ( DAL ).
Delta is up 145.16% over the last decade, while peers such as United Airlines ( UAL ) have risen 76.26% during the same time period.
Still, Delta has struggled since early 2021, when oil prices and inflation began to increase significantly, and the company was still dealing with Covid and pandemic related travel bans.
Even though Delta's refinery business enables the company to hedge fuel prices better than competitors, inflation and other economic factors have still had a significant negative impact on this carrier
I wrote in February of this year that Delta was buy because of the strong core airline business, the company's impressive balance sheet, the carriers unique ability to hedge higher fuels costs, and the low valuation. Delta is up nearly 17% since that time, while the S&P has risen by around 10% since earlier this year.
Today, I am upgrading my rating on Delta Air Lines from buy to strong buy. The company's core business is continuing to improve as air travel numbers rebound in the US and abroad, with the recovery in the Asia-Pacific region where the company has more leverage in particular beginning to accelerate. Delta is also better positioned than the company's peers to handle higher fuel costs because of the corporation's refinery holdings, and the stock also now looks significantly undervalued since the fundamentals of the airline industry have improved noticeably even since earlier this year.
Delta's second quarter earnings report was very strong, and the company's record numbers highlight how the fundamentals of the travel industry have significantly improved within the last six months, as well as the past year. Management stated that capacity rose 17% year-over-year, and unit revenues rose 1%. The company disclosed GAAP earnings were $2.84 a share, and revenues came in at $15.58 billion. Analyst expectations were for earnings of $2.40 a share, and revenue of $15.25 billion.
The leading carrier also reported that the company had record quarterly revenue and profitability levels, with net margins disclosed in the last quarter to be at the high end of the airliner's ten-year range, coming in at 5.36%.
The airline also raised guidance for 2023 to $6 to $7 dollars a share for 2023, up from the company's June guidance of $5 to $6 a share. Management stated that the company expects free cash flow to be $3 billion in 2023, and the company plans to repay $4 billion in debt by the end of the year. The main two reasons for Delta's strong quarter were lower fuel costs and increased demand, with travel numbers in Europe and the Asia-Pacific region particularly impressive. United Airlines ((UAL)) and American Airlines ( AAL ) also reported earnings beats as well. Delta continues to grow earnings at a double-digit rate, and the company's strong cash flow should give management flexibility to consider share buybacks as well. The carrier has $6 billion in cash and $6.9 billion in free cash flow, while carrying $28.69 billion in manageable long-term debt that management continues to reduce.
Trans-Atlantic travel and air traffic numbers in the Asia-Pacific region have rebounded much stronger than most analysts expected. Domestic air traffic in China rose by 536% on a year-to-year basis in the first quarter of this year alone. European carriers saw air traffic numbers increase by 14%. Overall travel numbers are also supposed to surpass prepandemic levels in 2024, and to double by 2040.
Investing always involves risk, and if oil prices were to rise significantly or economic growth were to slow noticeably, the more cyclical airline industries would obviously suffer. Delta also has more exposure to Asia than most airlines, so if China or the Asian-Pacific region saw a resurgence in Covid, more travel bans could again impact the company's operations in this area. Delta's refinery business also gives the company a key operating advantage in the current inflationary environment if oil prices remain high, but the company doesn't benefit as much as other air liners when energy prices fall because of the carrier's holding in this business.
Still, Delta looks significantly undervalued at current price level. The company trades right now at 7.25x expected forward GAAP earnings, 5.47x likely forward EBITDA, and 3.5x forecasted forward cash flow. The sector median valuation is 20.78x predicted forward GAAP earnings, 11.22x forecasted forward EBITDA, and 13.48x expected forward cash flow. Delta's balance sheet is stronger now too.
The carrier is also supposed to grow earnings at 14-16% per year on average over the next three years, and Delta's stronger balance sheet should remove concerns about solvency issues even if the economy deteriorates. Even though the airline industry is more cyclical, a company that is consistently growing earnings at 14-26% per year in this industry should trade at 9-10x expected earnings estimates for next year, or around $65-70 a share.
Delta Air Lines is the best run major carrier in the United States in my view, and the company is very well-positioned to benefit from what should be a strong multi-year cycle in domestic and international travel. The airline industry dealt with solvency issues during the financial collapse of 2008, and then again when the pandemic hit in 2020, but those events are not likely repeat themselves. While some investors remain unwilling to invest in the airline industry, Delta's best days are likely ahead of the company.
For further details see:
Delta: The Market Is Underestimating The Company's Strong Fundamentals