By Matt Doiron
A Form 4 filed with the SEC has disclosed that a grantor retained annuity trust operating on behalf of Delta Air Lines (DAL) Board member Paula Reynolds purchased 5,000 shares of stock on July 30th at an average price of $21.16 per share. Even though a purchase of 5000 shares may not seem like a big purchase, our research has shown that insider purchases over $100,000 perform better than smaller transactions. We keep an eye out for large insider purchases because economic theory states that insiders should generally avoid buying stock- it increases their company-specific risk when it is generally wiser to diversify one's wealth. As a result insider purchases can serve as an indicator that an insider is more confident than usual in the company, and in fact studies generally show a small outperformance effect for stocks bought by insiders (read our analysis of studies on insider trading).
Delta's revenue was about flat last quarter compared to the second quarter of 2012. With lower fuel costs and restructuring charges, however, this was sufficient for the airline to turn a profit of 80 cents per share compared to a loss in the prior year period. With Delta having essentially broken even during Q1, that is roughly what it earned in the first half of 2013. The stock now trades at 10 times trailing earnings, and while of course the airline industry is prone to bankruptcy and accordingly carries a good deal of risk this is certainly a low multiple in absolute terms. It's expected that airlines will gain pricing power as US Airways (LCC) merges with American Airlines, and Wall Street analysts are predicting considerable future earnings growth for Delta: the forward P/E is only 7 and the five-year PEG ratio is well below 1. The stock has more than doubled in the last year.
Insider Monkey tracks hedge fund activity in addition to insider purchases, including through quarterly 13F filings. We've found that 13Fs can be a useful source of information for developing investment strategies; for example, the most popular small cap stocks among hedge funds earn an average excess return of 18 percentage points per year (learn more about our small cap strategy). Despite the airline industry's poor reputation, we can see from our database that a number of funds own Delta and its peers. For example, billionaire George Soros's hedge fund owned about 9 million shares of Delta as of the end of March (find Soros's favorite stocks).
Other major airlines include US Airways, United Continental (UAL), Southwest Airlines (LUV), and Spirit Airlines (SAVE). US Airways and United Continental, the two other "legacy carriers", carry forward earnings multiples in the 6-7 range and so are priced similarly to Delta on that basis. With US Airways investors do have to concern themselves with integration risk, though bulls believe that the company also has the most upside from integration as it will gain significant market share on a number of major routes. Recent reports show the company's business about constant from its levels a year ago. United Continental, similarly to Delta, recorded a significant improvement on the bottom line in Q2 2012 versus a year earlier which was almost entirely due to lower costs. Further earnings growth stemming from higher margins may not be sustainable, but as has been mentioned the stock is fairly cheap in forward earnings terms.
Southwest and Spirit are discount airlines, and better market sentiment towards these companies results in these stocks being valued at a premium to the peers we've discussed. Southwest trades at 12 times forward earnings estimates, and like Delta boasts a low five-year PEG ratio. Its returns over the last year have been "only" about 50%, lower than the three legacy carriers, though actually the company's business has been about flat. It's a safer pick than Delta, US Airways, and United Continental but would also seem to have lower upside potential. Spirit features trailing and forward P/Es of 20 and 13 respectively, with analyst expectations being that good earnings growth would continue beyond 2014 as well. Its revenue was up 18% in its most recent quarter compared to the same period in the previous year, with profits rising at a slightly higher rate.
As a result Spirit may be worth looking into as a "growth at a reasonable price" stock. However, the insider purchase at Delta combined with its cheap valuation in terms of 2014 earnings and a plausible thesis that consolidation will help out large airlines makes it a good target for further research as well.