Strong Dollar Is A Positive For Delta Air Lines, Analyst Says

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May 02, 2015

In a recent research report, Imperial Capital analyst Bob McAdoo maintained an Outperform rating on Delta Air Lines (DAL, Financial) with a price target of $69 implying over 50% upside from the current levels. One area where McAdoo differs from fellow analysts is the impact of strong US dollar, which he believes will be "a net positive" for the company. According to him,

"While weaker foreign currencies will serve as a headwind to PRASM, this is more than offset by lower foreign currency denominated expenses and substantially lower jet fuel prices. This combination of impacts appears to be lost on many investors and some sell-side analysts."

Delta Airlines recently reported strong results with reported traffic increase of 3.6% and operating margin improvement of 90 bps. Going forward, Delta expects operating margin of 16% to 18% next quarter, assuming fuel price remains between $2.35-$2.40.

Delta is one of the cheapest S&P 500 stock trading at a forward PE of just 8 times. 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%. 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. 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. In addition to bringing down its debt levels, the company also repurchased $1.35 bn in stocks and paid out $251 mn in dividends last year.

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 9.4 times and 8 times FY2015 and FY2016 consensus EPS estimates, respectively. 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. Imperial Capital analyst Bob McAdoo believe that the company could trade at a multiple in line with S&P 500 Industrials average. In a research note sent after the company's investor day presentation last year, he 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.