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Is Delta Airlines A Buy Right Now?

An early 2012 rally in airline stocks has withered away in the middle of February as investors have reacted to surging oil prices. With West Texas Intermediate crude going above $105/barrel and Brent crude rising beyond $121 per barrel, the Delta Air Lines (DAL) price has dropped to around $10 a share off its 52-week high. The question for investors is whether or not this pullback makes Delta an attractive purchase? I looked at the company's fundamentals and have reviewed the company's market opportunities to see if Delta will be a lucrative investment in 2012.

Delta is the second largest airline by passenger miles travelled. The company has a current market capitalization near $39 billion and the stock has traded in a 52-week range of $6.41 to $11.64. Its earnings per share for the trailing twelve months are reported at $1.01, which gives it a price to earnings ratio of 9.89.

With airlines fuel costs being a major item to consider here, it is no surprise the recent run up in crude oil has hit the industry hard. Some estimates place increased costs for Delta to be near $3 billion in 2012. Howevern, I think these estimates are way too high, in part because of cost cutting initiatives launched by Delta in 2010 and 2011. Part of this is due to a fuel hedging program which, in 2011, generated $450 million in savings. Assuming the market plays out as expected, I believe those savings will accelerate. Delta has also initiated what it is billing as an aggressive operational cost cutting program. It is aggressively modernizing its fleet of planes that are more fuel efficient while also investing in more cost efficient baggage handling systems, although it is too soon to tell how effective that will be in the coming year.

Cost control will be especially important because there are a lot of problems with Delta's final accounts. True, its price to sales is a microscopic 0.24, but also gets an anemic 3.2% return on assets. Worse, Delta has a balance sheet that will ward off many an investor, with $3.68 billion in cash but $13.88 billion in debts. In fact, it has an alarming current ratio of only 0.61 and carries a negative book value of $-1.66 per share. Although the company was able to break a long run of negative cash flows with $350 million net cash in the 4th quarter of 2011, the company had $548 million net cash outflow the quarter before.

The company's operations are getting an upgrade, but the poor economic environment sided with high fuels costs is making it a tough road to travel. Unfortunately, those external factors do not look to get much better in 2012 and should drag on any company efforts to improve earnings or profit performance.

Delta seems to also be looking externally for growth, and published reports indicate Delta has contacted Goldman Sachs Group as well as Blackstone group to evaluate potential merger or acquisition possibilities. With most airlines stock trading at historical lows, many companies are thinking about consolidation. Rumors have US Air (LCC) and bankrupt America Airlines to be under Delta's magnifying glass. The trouble is while there is some sense as far as tying routes and operations together, all three are damaged companies with iffy balance sheets (especially bankrupt American), and it would take a lot of cash from somewhere to have a consolidation make sense from an economic stand point in the near term.

There are a lot of low priced airlines right now, and they are low priced for a reason.

To some extent investors have favored United Continental Holdings Inc (UAL) which topped out on February 3, 2012 at $25.84 a share, since then retreating to around $21. Like several other airline stocks, their balance sheet makes me cringe. It shows negative $6 billion in net assets, despite listing over $4 billion in questionable intangible assets. Meanwhile, Continental has a lot farther to go in updating its fleet.

The common denominator to Delta and these peers are their size, and with their low share valuation, the shaky financials make them iffy investments unless oil prices make a major retreat. Better options look to be with a pair of smaller airlines. The first one, Jetblue Airways Inc (JBLU), has a steady balance sheet, and with a price near $5, is almost equal to its book value. The company has strong growth prospects as it poaches customers off its bigger competition.

The second alternative to think about is Southwest Airlines Company Common (LUV), which has a book value per share of $8.90 per share, almost equal to its recent share price around $9. It too has been squeezed by gas prices, but it has a more modern, fuel efficient fleet than its rivals, and generally carries stronger brand loyalty than other airlines.

Delta's price is low, but with a weak balance sheet, and operational and cost issues bedeviling it, I cannot see how management's current look at possible merger or acquisition will help the company. I would not recommend buying Delta at this time. I do recommend that you consider the smaller airline stocks like Southwest or Jet Blue, which I believe are better positioned to perform now and heading into the coming quarters.

About the author:

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Rating: 3.5/5 (14 votes)

Comments

traderatwork
Traderatwork - 2 years ago
Beware, it's an airline company. Ask Mr. Buffett if he will buy it.

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