A look at Daniel Loeb's investment in Delta Airlines

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Mar 20, 2015
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Airline companies are notorious for burning cash. Serial Entrepreneur Richard Branson once said, "If you want to be a millionaire, start with a billion dollars and launch a new airline". With falling oil prices, things appear to have been turning around for the sector. Most of the airline stocks have seen good run up over the last few months backed by improved profitability. Many big name investors are now looking for quality names in the sector.

Last quarter, Billionaire Hedge fund manager Daniel Loeb (Trades, Portfolio) initiated a position in Delta Airlines (DAL) by buying 3.85 million shares. This is the first time he has taken a stake in the company.

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Delta's stock price has more than quadrupled over the last two years. Not only is the company benefiting from lower oil prices, it also has one of the best operational record in the sector and is returning cash aggressively to the shareholders. Here's a look.

Operational Excellence

Delta is one of the best airlines in terms of operational excellence. In 2014, the company had 95 days of no mainline cancellations, a completion factor of 99.8% and an on time rate of 85%, excluding the one time impact of winter storms in 1QFY2014. This excellent operational performance translates into revenue premium as customers are willing to pay for high quality services.

Improving Profitability, Debt Repayment and Share Buy Backs

The company's operational excellence coupled with the falling crude price is leading to improved profitability. Last quarter, Delta reported a $1 billion in pre-tax profit with EPS of $0.77 which beat consensus of $0.75. The company's margin expanded by over 400 basis points. Delta is judicially using its cash flow from improved profitability. The company has paid down $2.1 bn in debt last year and its net debt level at year end was $7.3 bn. This translates in $200 mn of annual interest savings. The company is now just two notches away from investment grade rating and plans to further bring down debt levels in the next two years. In addition to bringing down its debt levels, the company also repurchased $1.35 bn in stocks and paid out $251 mn in dividends.

Outlook and Valuation

Going forward, the company expects a significant increase in pretax profit in 2015 from fuel cost savings and the benefits of initiatives it is taking to increase its topline. The company plans to bring down its debt levels to $6 billion by the end of 2016. it also intends to significantly accelerate its capital returns and plans to spend a minimum of $1.5 bn in dividends and buy backs in 2015.

Delta's shares are trading at 9.76 time FY2015's consensus EPS estimates. Its forward annual dividend yield is 0.80%. Out of 18 analyst covering the company 16 are bullish and have buy recommendation, and two have hold ratings. Some analysts believe that the company could trade at a multiple in line with S&P500 Industrials average. In a research note sent after the company's investor day presentation last year, Imperial Capital analyst Bob McAdoo commented:

“Investor Day commentary outlines long-term operating goals and DAL’s belief, with which we concur, that the company should trade at multiples similar to other S&P Industrials. Within its Investor Day presentation on 12/11/14, Delta outlined its long-term operating and balance sheet goals. The company is targeting annual EPS growth of between 10% and 15%, consistent with consensus growth of 12% for other S&P 500 industrial companies. Operating margins should continue to be 11-14%, though we believe lower fuel prices could drive significantly higher operating margins in 2015.”

Given the company's operational excellence, history of returning cash to shareholders, fuel cost tailwinds and attractive valuation, I recommend buying the stock.