Summary
Delta Airlines is a BUY. The recovery from covid is here. The revenue is increasing and the margins are profitable. The earnings multiple is largely depressed and due for a reversion to the mean. With the expected increase in earnings and the reversion to the mean for the multiple provides the opportunity for a doubling of our investment.
Understanding Delta as a Business
Delta Airlines operates flights all across the world. They have a fleet of over 800 aircraft, and operate thousands of flights each day. The primary hub for their flight operations is out of the Atlanta international airport. Delta airlines operates in 3 main business segments. The largest segment being the passenger services segment, The second largest segment is the cargo services division, and the third and smallest segment is the maintenance, repair, and overhaul segment.
The passenger services segment of the business is the most significant portion of the revenue contributing to approximately 75% of revenue. This segment of the business is the most readily visible to the everyday consumer because it’s how we interact with the business. This business carries passengers to destinations throughout the country and world. The advantage that Delta has in the passenger services segment is their operational excellence. Delta has the best customer service, is the most punctual airline, and the best baggage handling. Delta is also the most innovative airline in terms of their passenger services. They were the first airline to offer inflight wifi and entertainment.
Delta’s management is intently focused on the operating margins. They are increasing their margins by increasing the amount of premium seats and fleet modernization. They are also increasing their brand loyalty with the offering on their sky miles credit card. They are seeing increases in loyalty with an increased number of participants in the credit card.
Another moat that all airlines have is the intense capital investment and regulations surrounding the airline industry. This prevents new players from joining the industry easily and limits the competition to the current competitors. Delta airlines outperforms the competition in terms of operational excellence.
Valuation Metrics
The finviz stock screener is a great tool to see performance metrics that are important to assess a company’s valuation.
Delta airlines are currently trading at a valuation of $23B by market cap. The current P/E is 7.73 and the forward P/E is 5.38. Another interesting metric is the price to sales ratio is less than 0.5. This means that you are getting a share for less than half of the current revenue. This doesn’t even take into account the future revenue of the business. The earnings for Delta are expected to rise by 32% for the next 5 years. Another interesting thing to look at is the Debt to equity ratio. Airlines were harmed by the covid shut downs. They aren’t in as bad a situation as they were a year ago and the level of debt is at a manageable level.
FAST Graphs Analysis
The FAST Graphs software is a powerful tool used to analyze the earnings of a company compared to the share price. The black line is share price and the orange line is earnings multiplied by 15. The blue line is the average PE ratio over the time frame plotted.
We can see that Delta has been steadily increasing their earnings from after the 08 crash until the covid crash of 2020. The analysts are expecting that the earnings will continue to grow up to $8 a share. The approximate of $8 a share is a return to the pre covid earnings.
Looking at the analyst scorecard provided by FAST Graphs we can see that the analysts have been very good at predicting the earnings of Delta with the exception of 2020 and 2021 when covid was affecting the business. The take away from this is that analyst price predictions can be taken to be decently accurate.
Bull Thesis
Delta airlines is the best airline in terms of operational excellence. They will continue to use this operational excellence to drive earnings higher. The FAST Graphs analysts are in agreement with the company’s forward guidance of getting to $8 a share. If the earnings do get to that level and they trade at the historic normal PE of 9 then we could see a doubling of our investment.
The earnings increase expectations is justified by the continuation of their operating margins and the revenue growth they are experiencing. The focus that the company has on delivering value to their customers is what you want to see from a company because customers are the heart of revenue. The debt they have is a completely manageable level and isn’t a concern at the current time.
Bear Thesis
For Delta airlines to be a viable investment for our portfolio they need to keep increasing their revenue while maintaining their current operating margins and that the market will increase the earnings multiple that it’s currently trading at. The revenue growth could be at risk because its cyclical and the macro economic trend could be pointing to a recession. In a recession people don’t fly as much. The fierce competition that exists in the airline industry is another threat to the revenue growth that is predicted. The margins could come under threat is the price of fuel. Airlines are dependent on the price of fuel since that is one of their largest operational costs. With war in the middle east the price of oil could skyrocket and lower the operating margins for Delta.
The earnings multiple could stay the same instead of increasing because of the threats to the revenue and margins. Investors could be pricing in the possibility for the future risks associated with the business. If there is no reversion to historic multiple then the growth in earnings isn’t enough for it to be a sustainable investment for the portfolio.
Rating
Basil Leaf Capital rates Delta Airlines a BUY. The operational excellence and focus on providing value to the customer is at the heart of this business. When flying Delta you can tell the difference between them and the other airlines. This focus on the customer is what will deliver the revenue growth that they are expecting. Delta airlines will surpass their pre covid earnings and should be trading at a multiple on par with their historic multiple of approximately 9. The debt from the covid crash is at a serviceable level and shouldn’t be an issue for the business. The company is addressing the fuel price cost by modernizing their fleet to more fuel efficient vehicles. The risk is more than priced in and makes the risk to reward ratio for this investment attractive.