Previously, I have discussed oil and gas companies. However, another industry I believe has the potential to outperform is the airline industry. The U.S. airline industry is expanding and I believe Delta Airlines (DAL, Financial) is well positioned to benefit. I will discuss why I am bullish on the stock and how the company is positioning itself to turn out to be the biggest in the industry.
Delta Airlines provides air transportation for both passengers and cargo in the United States and internationally. It operates in two segments - Airline and Refinery. The company also provides aircraft maintenance, repair and overhaul services, staffing, professional security and training services, aviation solutions to third parties, vacation packages to third-party consumers, aircraft charters, and aircraft management and programs. With a fleet of approximately 800 aircraft as of Feb. 3, the company has a solid foundation to provide consistent, sustainable results for shareholders.
Productive initiatives for cost reduction
Considering the impact of volatile fuel prices while simultaneously focusing on cost reduction, the company has been working on its upgauging and refleeting initiatives. Upgauging is a process in which the company boosts capacity by adding seats to existing jets while replacing smaller planes with bigger ones. This will help the company to cut down on its costs in the long run while providing a comfortable ride with the potential to provide better fares or an upgrade to its customers. Looking into the numbers, Delta Airlines will continue to upgauge by 7% for the next five years, preceded by a 5% increase since 2012.
On the other hand, the company has been taking advantage of low fuel prices in 2015 and 2016, using its notable portion of EBITDA to finance a younger and more fuel-efficient fleet of aircraft. These initiatives are estimated to provide $350 million in savings in fiscal 2016. Hence, as the time was right for the refleeting decision, I believe Delta Airlines has been well focused in creating fuel-efficient aircraft that will provide better margins even when fuel prices start rallying.
Strong financials
Delta Airlines has strong financials that have been improving over the years. Though the revenue for the first nine months of the year is less than that of the same period in 2015 and 2014, the company has been reporting better operating and EBITDA margins. Better margins indicate well-managed operations and increasing efficiency of the management.
What is interesting to note is that there has been a 10% increase in both the operating margin and the EBITDA margin since 2014. This is primarily due to lower fuel prices. As discussed previously, airlines like Delta have benefited from this.
However, margin growth has been relatively muted in the last year due to volatile fuel prices and unit revenue decline. Still, the company has been able to meets its estimated operating margin of 19% and EPS growth of more than 15%.
| Parameters (numbers in millions) | 9M2016 | 9M2015 | 9M2014 |
| Revenue | $30181 | $31202 | $30715 |
| Operating Profit | $5932 | $6085 | $3034 |
| Operating Margin | 19.7% | 19.5% | 9.9% |
| EBITDA | $7362 | $7469 | $4367 |
| EBITDA margin | 24.4% | 23.9% | 14.2% |
| Operating Cash Flow | $6080 | $6448 | $4365 |
| Free cash flow | $3483 | $4381 | $2776 |
One of the biggest investment positives for Delta Airlines is its healthy cash flow. With the first nine months of the year operating cash flow of $6.1 billion and free cash flow of $3.5 billion, the company has ample funds to invest in its fleet expansion and upgauging initiatives while providing sufficient returns to its investors at the same time.
Valuation
Even with 50% gain in the last six months, Delta Airlines is still trading at a price-earnings ratio of 8.1, which is much lower than the current industry average price-earnings ratio of 11.6. Comparing the company’s EV/EBITDA of 5.1 with Southwest Airlines’ (LUV, Financial) 5.6 and American Airlines’ (AAL, Financial) 5.2, the company looks fairly valued. However, compared the industry as a whole, Delta Airlines still has the potential to outperform considering strong financials and sustained operating efficiency.
Conclusion
Delta Airlines long-term financial goals have resulted in improved margins, better returns on invested capital and an improved balance sheet. Excellent cash flows further reflect the ability of the company to expand its business through capital expenditure investments. The company expects to increase its annual dividend by 50% in fiscal 2016 and accelerate its buybacks with excess free cash flow to create shareholder wealth. Thus, considering the company’s effort to maintain a balanced capital deployment, I believe Delta Airlines is a good long-term investment.
Disclosure: No position in the stocks discussed.
Start a free 7-day trial of Premium Membership to GuruFocus.
