The US airline industry in 2013 will see some key trends define winners and losers among airlines: higher fares resulting from industry consolidation, an expected increase in demand, and potential increase in oil prices. Delta (NYSE:DAL) is uniquely positioned among peers to benefit from these trends.
Airline consolidation has already proven in the past to determine capacity reduction and decreased competition. All airlines will theoretically benefit from a US Airways (LCC) - American Airlines (AAMRQ.PK) merger, starting from airlines directly impacted by a fewer number of competing flights on their existing routes: Delta, United (NYSE:UAL) and Southwest (NYSE:LUV). US Airways will likely need to resolve post-merger integration first, and will be able to capture benefits from the merger in the medium term. In this context, Delta is in a favorable position to take advantage of a fewer number of competitors. Its plan for 2013 of continuing to move away from 50-seat jets to have planes with First and Economy Comfort Classes is a sign of the targeted increase in revenue per seat mile.
IATA expects increased demand and profits for the US airline industry in 2013. With increasing customer loyalty, Delta will see stable revenue growth. Its planned acquisition of a 49% equity stake in Virgin Atlantic will contribute to revenue synergies from a larger international network and stronger Heathrow presence, allowing Delta to further benefit from the international and corporate flight revenue momentum.
Delta's acquisition of the Trainer refinery has been widely criticized as venturing beyond the company's core skills, especially when, in Q4, Delta reported a loss of $63M at the facility. However, Sandy had a major role in the loss as the plant was damaged and had to slow down output. These problems will be resolved in the course of 2013. On the other hand, Delta's modifications to the plant will maximize production of jet fuel from the normal 14% of total 185K barrels per day output to a planned 32%. The rest will be swapped with BP and Phillips 66 in exchange for jet fuel. Such strategy will help Delta reduce fuel cost by at least $300M per year, not considering likely increases in jet crack spread.
The merit of the acquisition goes beyond simple cost reduction from vertical integration, as Delta is set to benefit from increased market interest in the cheaper Bakken oil from North Dakota. Several projects are being funded to transport Bakken oil to Northern Eastern refineries, and 2013 is expected to see the overall number of barrels shipped per day to increase two to three-fold. With a rail terminal for North Dakota oil being built outside Philadelphia, just 20 miles from the Trainer refinery, Delta finds itself ahead of competition in finding new effective ways to reduce its fuel cost.
Delta will start taking full advantage of the above mentioned trends halfway through 2013. H1 is likely to see the share price slightly decrease from the new high of ~$15 likely to be reached in Q1, as the company works on addressing final problems at the Trainer facility and faces the expected 4-6% increase in non-fuel unit costs. After reaching a low in Q2, I believe the share price will increase towards a $16 value.
A bullish view is supported by fundamentals. Net debt has decreased at 11% CAGR since 2009, and is set to further decline as the company targets a $10Bn value in 2013. The P/E ratio at 12.14 is higher than most peers, while a 0.21 PEG ratio shows the company is undervalued.