Delta: "Compelling Value"

06/23/2016 7:00 am EST

Focus: STOCKS

Out latest Focus Stock — which carries S&P Global Market Intelligence’s highest strong buy ranking of 5-STARS, or Strong Buy — is the third-largest passenger airline in the US, notes Jim Corridore, S&P Global Equity analyst, in The Outlook.

We think Delta Air Lines (DAL) is well ahead of peers in financial performance.

On top of that, given our positive view of the US airline industry, we think the company is extremely well positioned to benefit from positive trends in demand, costs, cash generation, and profits, which we expect to continue.

In October 2008, Delta completed a merger with Northwest Airline; it was the first to consolidate and grow its global network through a merger.

This head start enabled Delta to complete merger integration way ahead of other airlines and has given it an advantage in unit revenues and unit costs. Delta now serves 328 destinations in 57 countries.

Delta has also generated a tremendous amount of cash and has used that cash in very creative ways, in addition to cutting debt, buying back stock, and paying a dividend that has been rising over time.

Delta, along with the entire US airline industry, has benefited tremendously from lower oil prices. Total fuel costs dropped to $7.6 billion in 2015, from $13.5 billion in 2014.

We expect fuel costs to fall again in 2016, though by a much smaller amount. Average price per gallon paid dropped to $1.90 in 2015, from $3.47 in 2014.

Recent moves by Delta to reduce capacity should enable the airline to maintain pricing power and make for strong summer profits.

We expect fuller flights at slightly higher fares in the second and third quarters of 2016 versus 2015. This, along with low energy prices, should drive strong profits for Delta in 2016.

Along with these strong profit comes strong cash generation. Delta has used this cash to cut its net debt (long-term debt minus cash) to $6.7 billion at the end of 2015, from $15 billion at the end of 2010. Delta plans for net debt to be $5.0 billion by the end of 2016.

Other creative uses of its cash include the 2012 purchase of an oil refinery that provides Delta with protection against swings in the cost to refine oil into jet fuel and which required a relatively small investment of $250 million.

Risks to our opinion and target price include possible higher oil prices, intensifying price competition, and a slower economic recovery. Worries about the Zika virus and terrorist incidents represent additional risks.

We find the current valuation of six times forward EPS extremely compelling, and expect the shares to significantly outperform the market over the next 12-months.

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By Jim Corridore, S&P Global Equity Analyst in The Outlook

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