Description

The perils of investing in the airline industry are well-studied and well-known. For investors with thicker blubber than the rest, we believe that Delta shares are underpriced. Delta is a company which enjoys a high reputation and appears to be one of the best players in one of the worst industries. Being the best of the worst sits somewhere between high quality and distress, and certainly in the zip code of “value”. The company is highly leveraged from the pandemic and thus requests the presence of investors comfortable with debt analysis.

Delta held an investor day in February of 2022, and again most recently in December of 2022. CEO Ed Bastian must be aware of the “headwinds” in promoting his company — a high-fixed cost business selling a semi-discretionary product, especially at a time when the cognoscentis of the economy look into their magic-8-balls and whisper: “late-cycle”. One would guess the prognostications of these magicians are on his mind as he stands on the podium and promises that seven dollars of earnings-per-share in 2024. Said more plainly, I would guess that his guidance is conservative. Presently, DAL trades at $39, or roughly five and a half times Mr. Bastian’s targeted earnings.

In the meantime, following is a background on Delta. It is likely the best (or, second best) airline business in the world and enjoys a very high reputation from consumers and investors. Delta has a more premium product than the other mainstream American carriers and consistently offers good service while running their trains (planes?) on time. (The Wall Street Journal normally crowns DAL as the best carrier in the United States.) The business mix is skewed to the high-end and presently, less than 5% of Delta’s revenues are from restricted economy fares. These developments are very much of the last ten years and can be credited to Mr. Bastian’s operational prowess. 

Delta’s goals for 2024 are as follows. 

1. Grow revenue to north of $60B from $50B in 2022. (This represents a 5% CAGR from 2019 revenues of $47B.)
   
   
2. Operate the business with 13-15% margins, which appears reasonable as operating margins averaged 14.5% in the period 2015–2019. 
   
   
3. In all, yield an EPS of $7+.
   
   
4. Further, Delta hopes to generate $9B of cash from operations, $5B capex and thus $4B of free cash flow in 2024. Therefore, Debt/EBITDAR is to be reduced from 5x presently to 2-3x. 

As written above, Delta offers a relatively premium and differentiated product than competition. Case in point, the mix of premium seats in 2009 was under 9% and by 2019, the mix improved to 28%. Mr. Bastian’s goal is to drive the mix north of 30% over the next two years. Thus, the contribution of premium cabin tickets, the American Express business and other fees to revenues has grown from 40% in the early 2010s to 55-60% presently. This is in part due to better monetization of first class and premium economy, and significant growth in the Amex business. Delta is competing much less with Spirit, Frontier, or Jetblue than is United or American. It is my guess that as the premium products account for most of revenues, that they are responsible for almost all of Delta’s profits.

A note about the Amex business. Delta plans to continue to expand their American Express partnership which has grown by about 50% since 2017. The most high-end Amex/Delta card bears an annual fee of $550. In 2022, Delta extended their deal to 2029. The program allows for Amex to purchase miles from Delta as cardholders spend money, which are then redeemed for travel. The positive is two-fold — it promises future business for Delta and as the deferred revenue balance grows, provides a cash contribution of about $300-500m each year. Delta hopes to grow the program another 30% by 2024. 

Some details on the balance sheet, which is obviously weak. The numbers are in billions and are as of December 2022:

Gross debt as of December 2019            10.1
Debt issued since Covid began                30.2
Debt paid back since Covid began          (17.3)                  
Gross debt as of December 2022             23.0
Lease liabilities and other                         7.6
Cash balance                                           (6.5)           
Net debt                                                    24.1

The maturities are not optimal as about $7B of the debt is coming due before the close of 2025. Finally, about $2.7B of the gross debt is floating.

Overall we think about the business as follows. It is a very well-managed company which enjoys a good reputation and offers a relatively differentiated product. The business operates in a very poor industry. Assuming one is comfortable with the debt and determines that the company will continue to be of going concern, the “good” airlines may become stocks to own on a stormy day and sell when they see their day in the sun. Presently, the sentiment around airlines is fairly negative, and if we had to purchase an airline Delta would be near the top of our list. 

Between 2014 and 2019, Delta has traded at an average of 10.4x on earnings per share. In 2016, 2017, 2018, and 2019, the average multiples were 9.7x, 11.8x, 8.9x, 7.7x, respectively. If we assume Ed Bastian is correct and that the company can generate $7 or more per share, we can value this at 9x earnings which implies a $63 stock price, or about 60-65% upside from today’s prices. 

DISCLAIMER: This is intended for information purposes only (not investment advice) and should not be relied upon solely as a basis for investment. The author may hold a position in the issuer and undertakes no obligation to update any future changes in the position or in the investment opinions expressed herein.

Catalyst

Delta is the strongest player in a recovering and poorly-received industry.