Delta Air Lines Inc. (DAL, Financial) is the second largest U.S. airline and the largest transatlantic carrier in the world. Its route network operates around the hub system, including airports in Atlanta, Detroit, New York (JFK International Airport), Paris – Charles de Gaulle, and Tokyo – Narita, among others. After enjoying a solid fiscal year in 2013, the company’s strategy is set to focus on improving operational efficiency, enhancing customer experience and balancing capital deployment, so as to increase shareholder returns. Thus, several investment gurus like George Soros (Trades, Portfolio) and Whitney Tilson (Trades, Portfolio) are placing their bets on Delta’s profitability, having bought the company’s stock this past quarter.
Consistent Improvement as the Key Growth Driver
Delta’s management team has consistently reiterated its goal of improving operating efficiency and customer experience in the past, and this goal will continue going forward. In June 2013, for example, the firm finished acquiring a 49% stake in British carrier Virgin Atlantic. This move also established a profit sharing agreement, connecting 66 destinations across North America and the UK, which will augment the carrier’s presence in the top 10 U.S.-Europe destinations. Until now, success has come in the form of $25 million in codeshare revenues generated this past fiscal year. Furthermore, the firm’s aim to fortify its Latin American presence has led to another important code share deal with leading Latin American airline GOL Linhas Aereas Inteligentes. The agreement will enable Delta to access 23 destinations in Brazil, as well as establish a direct route from New York and Atlanta to Sao Paolo.
On another note, Delta recently announced that its SkyMiles program would be changing on Jan. 1, 2015, making it more similar to the loyalty programs offered by competitors JetBlue Airways Corp. (JBLU, Financial) and Southwest Airlines Co. (LUV, Financial). As such, it will reward passengers based on the price of their ticket, instead of the miles flown, thereby increasing loyalty among frequent fliers. In addition to this, management declared that it will be investing $2.0 billion to $2.5 billion annually for the next five years, in order to enhance its fleet structure and technological base. The installation of full flatbed seats on long haul flights, Wi-Fi service and renovated interiors in all narrow-bodied aircraft by 2017 will extend the longevity of Delta’s fleet, thus reducing carrier capital expenditure. Moreover, the firm’s fuel hedging strategies, reduction of operations in unprofitable airports, and fuel-friendly airplanes to replace older jets, will enhance operational efficiency and help reach management’s target cost reduction of $1 billion over the next few years.
Valuation
Although Delta’s capital expenditure for 2014 will range around $2.3 billion, targeted mainly to fleet restructuring, I believe this investment will be very profitable in the long term, reducing overall cost of capital. Furthermore, despite the acquisition of Virgin Atlantic, the carrier managed to lower its net debt to $9.4 billion, a trend which will continue looking forward ($7 billion expected by the end of 2015). While 2013’s 5.3% revenue growth should slow down to an average 4%, with 3% capacity expansion, the current operating margins of 9% will grow to 12% for 2014, due to a strong demand environment and strategic initiatives.
Furthermore, Delta has done a good job at maintaining its ROE levels at 15.94%, in addition 17.3% EBITDA growth. Also, the company’s earnings per share have been augmenting at a spectacular 159.8% growth rate, jumping from Dec. 2012’s $1.19 to a very profitable $12.3 at the moment. I also remain impressed by the firm’s ability to increase its cash flow, having more than tripled its sum between 2013 ($508 million) and 2014 ($1.9 billion). In addition to the stock’s bargain trading price of 2.7x trailing earnings relative to the industry average of 12.7x, I think Delta is an all-round winning investment.
Disclosure: Patricio Kehoe holds no position in any stocks mentioned.
