Every time I see interest increase in the airline industry, I think about two quotes from two of my most favorite billionaires.
Richard Branson once stated that “if you want to be a millionaire, start with a billion dollars and launch a new airline.”
Buffett has said that “investors have poured their money into airlines and airline manufacturers for 100 years with terrible results, it’s been a death trap…”
So, why are guru investors like David Tepper (Trades, Portfolio), Joel Greenblatt (Trades, Portfolio), Robert Olstein (Trades, Portfolio), and Daniel Loeb (Trades, Portfolio) putting millions of dollars into Delta Air Lines (DAL, Financial)?
I’m going to pick this stock apart real quick.
For one, Delta has a market value of $34 billion and the earnings multiple is upwards of 30x. Even if Wall Street analyst estimates are 100% right (how likely is that?) on the company, and its earnings explode up to between $4.25 and $5.00 per share, is this sustainable?
The reason for this jump in EPS will likely come, in part at least, from the $5 billion buy back program. However, it’s likely the company will finance some of that buyback with debt.
What happens when oil prices rise? Maybe Delta did a good job hedging and will be able to supply its planes for years to come on the back of cheap oil, but how long will that last? Over the last year, Delta generated north of $2 billion in pre-tax income from lower fuel prices. Management thinks DAL can keep EPS growth at 15% or higher over the next several years, factoring in higher oil prices.
With share buybacks of $5 billion cutting the current total shares down to around 700 million and factoring in a 15% increase in earnings for the next 3 years, I get a net income of around $2 billion and earnings per share of $2.85. A far cry from the $5 per share mark, but I’m probably missing something, but in my experience airlines do not garner 30x multiples.
Over the long term, the consistency of airline companies like Delta is hard to value. If the stock hits the $5 mark set by analysts, the multiple will likely contract down to 15 to 20, but the stock would still be up 50% to 100%.
Guru ownership
David Tepper (Trades, Portfolio) manages over $4.2 billion, and 5% of that is in DAL.
Daniel Loeb (Trades, Portfolio) manages $10 billion, and 2.3% is in DAL.
These are big positions that I believe will end up losing. In fact, right now, the average buy-in price point on DAL is around $45, and the stock trades at $42. If you believe that the value of the earnings and future cash flow is high, now could be a good time to piggyback these bargains.
However, what come to my mind is the 2008 annual letter to shareholders of Berkshire Hathaway in which Warren Buffett (Trades, Portfolio) states the following. “The worst sort of business is one that grows rapidly, requires significant capital to engender the growth, and then earns little or no money. Think airlines.”
Have these guru investors found something different or have they simply forgot to heed this warning?
