Seeking Alpha
Long only, value, special situations
Profile| Send Message| ()  

Today, I am going to discuss the stock price changes in Delta Air Lines Inc. (DAL) due to an improving economy, declining trend in the fuel cost, and escalating traveling trends around the globe.

Industry Outlook

The International Air Travel Association (AITA) anticipates a robust growth in profit margins during year 2014. As per the press release in December 2013, the association has revised its profit forecast for the present year by 20% to $19.7 billion compared to its September forecast of $16.4 billion. The upward revision in the profit forecast underscores several improving industry factors with fuel and passenger demand being key contributors.

Worldwide travel is visibly on the rise as depicted by the rising air travel demand on the part of passengers which is expected to show a growth rate of 6%. Further improvement in the profit margins will come from declining fuel costs which is expected to decline to $104.5/barrel from $108.2/barrel in 2013. This cut in the fuel cost will translate into a cost reduction of at least $5 billion for the air travel industry.

Delta's Projected Performance

With regards to Delta's financials 90% of the company's revenues come from passenger traveling. Since passenger traveling is expected to shoot up in the upcoming future Delta's revenues are projected to be higher than the current level. The higher revenues will then lead to higher profit margins. Delta hopes to generate profits of approximately $2 billion this year.

To capitalise on the rising passenger demand for air travel the company has shifted its focus on bringing about changes that will enhance per passenger revenue. Delta is expected to revamp the design structure of 225 planes by increasing the number of passenger seats and installing larger overhead bins. The project is expected to end by 2016 with an estimated cost of $770 million wherein bin size will increase the space of carry-on baggage space by about 50-60% and seat installation will be done without decreasing the leg space of travelers. Furthermore, seats are expected to be wider weigh approximately 30% less and take up less space due to their sleeker shapes compared to traditional plane seats. Lighter seats will further cut down the company's fuel cost in addition to the lower-priced fuel barrels.

Analysis

Comparing Delta's performance against its peers I discovered that the company's return on equity ratio exceeds the industry average by about 89 times. In order to understand the reason why it is deviating from the industry by such an enormous ratio I conducted the DuPont Analysis.

Source: Quarterly Report

My calculation shows that Delta's ROE is artificially inflated due to its extremely high debt position which is apparent from its financial leverage ratio. This is also indicated by the very high debt to equity ratio of the company where the company's debt/equity stands at 73.55 against the industry average of 2.66. However, the company has been paying off its debt gradually over the past three quarters and hopes to reduce it significantly over the current fiscal year. Improving its CFO/Debt ratio also favours the company depicting the fact that Delta is able to pay off debt from its operating cash flows.

The forward P/E ratio (11.33) of the company is projected to be lower than the current P/E ratio (12.34).A lower forward P/E ratio is a clear depiction of a higher EPS in the future which is backed by the fact that the company's financial stance is improving.

Threat of Losing Market Share

As of today, Delta operates about 4,000 domestic and international flights on a daily basis. Within the US, Delta's flights operate from about 18 states. However, the company faces a threat in the form of losing its existing and potential travelers to the new merged airline, American Airlines Group (AAL), which was formed by a merger between two American Airlines (AMR) and US Airways Group (LCC). The merger has better positioned the American Airlines Group against Delta for two reasons: 1) It would be spread across 50 states in the US; 2) It is projected to operate an average of 6,700 flights per day.

Delta should not take the merger lightly as a large chunk (65%) of the total revenues of the company pour in from its domestic passengers. Considering that American Airlines Group would have better market penetration in the US market and that it would also operate a higher number of flights per day compared to Delta it is reasonable to assume that Delta would lose some of its customers to the merged company.

However, American Airlines Group is expected to charge a higher flight fare to passengers and that might prevent some customers from switching to the new airline. Plus the merged companies will take a couple of years to fully integrate which gives Delta a considerable amount of time to better position itself against the new competition.

Concluding Remarks

The industry outlook will favorably impact the performance of the company both in terms of profit margins and performance in the stock market. Improving profit margins, declining debt and a positive trend in the CFO/Debt ratio also indicates the fact that the company's stance is improving. Therefore, it is highly likely that the stock price of the company will climb higher this year which makes it a good candidate for investment. The only threat facing the company is the merger of American Airlines and the US Airways Group whose actual impact is yet to be seen.

Source: Delta Air Lines - A Good Candidate For Investment