Georgia-based Delta Air Lines (DAL, Financial) announced its first-quarter results early this month, reporting a 1% sales decline to $9.15 billion and an unimpressive 36% profit decline to $603 million – a 6.6% profit margin vs. 10.2% in the first quarter of 2016.
As observed, fuel regional carriers expense grew 45% to $242 million during the quarter, with overall operating expenses growing 5%, affecting Delta’s bottom line.
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“Despite fuel price pressures, the Delta people once again delivered solid results across the board with double-digit operating margins, strong improvements in customer satisfaction and progress on our international expansion with the closing of our Aeroméxico transaction.
“Producing these results in our toughest quarter of the year shows not only how far we’ve come, but also that we have more opportunity in front of us to continue building a better airline for our employees, customers and owners.” – Ed Bastian, Delta CEO
Delta shares fell 2.3% post earnings and guidance release.
Total returns
Delta failed to return any gains this year to its shareholders with 7% total losses compared to Standard & Poor's 500’s 5.5% total gains, according to Morningstar data. The airline, however, has outperformed the index in the past five years with 34.5% total gains vs. the index’s 13.7%.
Valuations
Delta is undervalued in terms of valuations by earnings when compared to peers. According to GuruFocus data, Delta had a trailing price-earnings (P/E) ratio of 8.4 times vs. industry median of 10 times, a price-book (P/B) value of 2.6 times vs. 1.6 times and a price-sales (P/S) ratio of 0.86 times vs. 0.67 times.
Delta also had trailing dividend yield of 1.63% with a 14% payout ratio.
In terms of fiscal 2017 sales and earnings-per-share expectations, Delta had forward valuation multiples of 0.8 times and 8.9 times.
(10-K)
Delta Air Lines
Delta Air Lines was founded in May 1924. According to filings, the airline provides scheduled air transportation for passengers and cargo throughout the U.S. and around the world.
Delta also has international alliance relationships with foreign carriers whereas it has three joint ventures: transatlantic joint ventures with Air France-KLM (XPAR:AF, Financial), with Virgin Atlantic Airways and with Virgin Australia Airlines and its affiliated carriers.
In fiscal 2016, Delta generated 71% of its business from domestic U.S., 15% from the Atlantic, 7% each from the Pacific and Latin America.
Delta had two operating segments: airline segment and refinery segment.
(10-K and 10-Q)
Airline
According to filings, the airline segment is managed by Delta as a single business unit that provides scheduled air transportation for passengers and cargo throughout the U.S. and around the world and other ancillary airline services.
In the first quarter, sales in Delta’s airline business fell by 0.9% to $9.09 billion –Â 89% of total sales excluding adjustments –Â and logged an operating margin of 11.1% compared to 17.1% in the first quarter of 2016.
As observed, part of the overall higher operational expense was related to increases in salaries and related costs, regional carrier expense and aircraft maintenance. Further, salaries and related costs were higher as a result of contractual pay rate increases for pilots, according to filings.
In addition, a metric called cost per available seat mile increased to 13.99 cents from 13.26 cents in the year ago quarter, while passenger revenue per available seat mile declined to 13.28 cents from 13.35 cents.
(10-K and 10-Q)
Refinery
The refinery segment operates for the benefit of the airline segment by providing jet fuel to the airline segment from its own production and through jet fuel obtained via exchange agreements with third parties. The refinery's production consists of jet fuel as well as nonjet fuel products.
In the first quarter, Refinery sales grew by 47.5% to $1.13 billion and delivered an operating margin of 3.9% or $44 million vs. losses amounting to $28 million in the first quarter.
Total operating revenue and net income
(10-K and earnings release)
On a three-year average, Delta had sales growth of 1.6%, profit losses of 25.4% and profit margin of 7.9%.
Cash, debt and book value
As of March, Delta had $2.65 billion in cash and cash equivalents including short-term investments and $9.23 billion in debt and capital leases resulting to a debt-equity ratio of 0.71 times vs. 0.75 times in a year earlier.
Of Delta’s $51.5 billion assets 28.5%Â were identified as goodwill and intangibles having had a book value of $12.95 billion compared to $11.3 billion the year prior.
Pension (noncurrent liabilities)
Cash flow
(Earnings Release)
In the first quarter, Delta exhibited $801 million cash out flow from its operations brought by good amount of cash outflow from pension payments expenses in addition to the lower profits in the quarter.
(10-K and news release)
Capital expenditures were $802 million leaving Delta with $1.6 billion in free cash (out)flow compared to $140 million in the year-ago quarter. Despite the negative free cash (out)flow, the airline allocated some $349 million in shareholder dividends and stock buybacks, whereas the company allocated 61% of its free cash flow in shareholder payouts in the recent three fiscal years.
(10-K and news release)
In addition, Delta took $1.72 billion in obligation proceeds during the first quarter.
Conclusion
Being the second-best airline in terms of quality and performance (airline quality rating) among its other peers, Delta disappointed its shareholders with its profit performance during the early stage of its fiscal 2017 operations.
Delta’s other segment, refinery, has somewhat (11% of total sales) helped alleviate the decline experienced by its airline business but still has ways to go to match its previous year's business sales level. Refinery earnings have turned positive once again in the first quarter after delivering losses in fiscal 2016.
Delta also has an acceptable leveraged balance sheet while carrying a good amount of intangibles.
The airline also experienced heavy cash flow reduction in relation to its pension expenses in the first quarter alone in comparison to the previous year, which led to an unappealing free cash flow situation.
(Delta Air and P/S Ratio, GuruFocus)
Meanwhile, 14 analysts had a median target of $60.50 a share or 64.7% upside from $45.53 per share (at the time of writing).
Using three-year sales growth and P/S multiple average followed by an application of a 25% margin would indicate a value of $31.2 billion or $42.7 per share.
In summary, Delta Air is a hold with a value of $45 per share.
Disclosure: I do not have shares in any of the companies mentioned.
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