Delta Air Lines: Lean and Mean

10/13/2016 8:00 am EST


Jason Clark

Contributing Editor, The Prudent Speculator

Airline investing over the years has been exceptionally difficult. While there have been no shortage of lost capital and bankruptcies, we argue that the airline industry isn’t the same as it once was, suggests value investor Jason Clark in The Prudent Speculator.

After reducing costs by more than $3 billion per year, Delta Air Lines (DAL) emerge from bankruptcy in 2007.

Delta – which merged with Northwest Airlines – eventually turned its eyes back to growth by the end of the decade, with one of its many moves including expansion of its Los Angeles operations by nearly 50% to better compete in Asia.

Delta – which merged with Northwest Airlines – has definitely improved its operations since its financial difficulties of the early 2000’s.

It’s lean and mean approach to its route network means that airplanes are operating as full as ever, with an average load factor of 85.5%.

The firm suffered a tech outage this summer, which could provide for some short-term volatility when the company reports on October 25. However, Delta has already moved to elevate the skill set of its IT/infrastructure team.

Meanwhile, Delta is the most profitable of the three legacy airlines (including American and United/Continental), and is the only one of the three that fully integrated its merger.

As Delta's profitability improves, we expect the company to remain disciplined with CAPEX enabling management to pass capital back to shareholders. 

Our true investment interest starts and stops with valuation. We like that DAL has one of the lowest forward price to earnings ratio of the mainline US carriers (6.8x).

Additionally, this multiple is lower than the firm’s three- and five-year average P/E ratios of 10.8 and 9.3, respectively.

DAL also currently trades with an EV/EBITDA multiple of 3.5, which compares to its three and five year averages of 5.2 and 5.5, respectively, and is the lowest of the mainline carriers.

We also believe that Delta has an underappreciated free cash flow story; its expected strong free cash flow generation should allow DAL to continue to address its pension deficit, de-risk the balance sheet and return cash to shareholders.

We like Delta’s attractive valuation and its underappreciated free cash flow generation story. Our current Target Price on DAL shares is $63.

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