Delta Airlines’ (DAL, Financial) stock price has corrected ~10% over the last couple of weeks. The main culprit was the disappointing March traffic report. Delta said Thursday that March passenger revenue per available seat mile "was flat year over year, as domestic strength offset pressure in international markets, predominantly from currency fluctuations." On the positive side, the company said that it expects current quarter unit costs excluding fuel and profit-sharing to be down 1%, compared with prior guidance of flat costs.
Stifel’s analysts Joseph DeNardi believes that the company’s shares are attractively valued and and investors should consider buying it despite of the disappointing PRASM data. He wrote,
“Delta provided an investor update … and reaffirmed its prior operating margin guidance for 1Q of 8%-9%, but PRASM came in lower than expected at down 1.5% compared to the prior guidance of down 1.0%. Delta attributed the PRASM miss to FX headwinds that were more meaningful than expected in March and weaker than expected domestic pricing in March. Margin guidance was maintained despite the lower PRASM due to a ~1pt benefit to CASM-ex from FX…
Valuation Keeps Us Interested Despite Near-term Pricing Risk: Shares are trading at 7x our 2016 EPS estimate which assumes ~$1.92 average jet fuel cost next year. Assuming a jet fuel price of ~$2.40 (roughly $70/bbl crude oil) lowers our estimate to $4.40 holding all other variables constant (which we view as a very conservative assumption) for a P/E multiple of 10x – still very attractive given healthy underlying fundamentals in the industry. As a result, we maintain our Buy rating and $65 target which is based on shares trading at 11x our 2016 EPS estimate.”
I believe investors should follow Joseph DeNardi’s advice and buy Delta. 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 records in the sector and is returning cash aggressively to the shareholders. 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.
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.
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 9.13 times FY2015's consensus EPS estimates. Its forward annual dividend yield is 0.80%. Out of 18 analysts covering the company 15 are bullish and have buy recommendation, and three have hold ratings. Given the company's operational excellence, history of returning cash to shareholders, fuel cost tailwinds and attractive valuation, I recommend buying the stock.
