Delta Air Lines: A Stock To Keep

| About: Delta Air (DAL)

Delta Air Lines Inc. (NYSE:DAL) is among the few airlines with an extensive US domestic and international network enabling it to serve a wide array of travelers. The company operates nearly 4000 flights per day. Add the facts above and we have a strong player that operates within a growing aviation industry. The company also runs a cargo business to generate revenues and implements certain add on charges for services that include preferential seating, extra baggage, and access to premium lounges.

Past Performance

Positive Macro Environment Resulted in Strong Third Quarter Results

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Source: 10-Q

During the last quarter, the company saw some favourable macro factors that boosted its results. Total revenue jumped up 6% to $10.5 billion showing an improvement of more than half a billion from 3Q12's figure. Higher fares and increasing traffic contributed towards the increase. Passenger traffic rose 2% whereas average fare paid per mile per customer received a 5% increment. The Latin American region saw the highest growth (16%) in revenues owing to traffic rise (14%) as well as some (2%) positive passenger mile yield.

Operating expenses remained relatively stable increasing by $312 million (1%) from 2012 with cost per mile at $13.97 cents. The increase was a result of higher salaries, fuel costs as well as profit sharing expense.

Delta's Refinery & Hedging program has the Potential to bring Stability to Fuel Costs

One of the largest determinants of the company's profits is its fuel expense. Last quarter alone, fuel costs made up 32% ($2.8 billion) of the company's total operating expenses. The market price per gallon temporarily declined by 3% year over year this quarter though higher capacity increased total consumption by 3%. Fortunately, the net result was positive as realized average price per gallon declined 17% to $2.97.

This decline was only temporary as the general trend in fuel costs is sloping upwards. This is because the global demand for jet fuel is rising owing to greater consumption whereas jet fuel refining capacity is on the decline. To mitigate the price volatility Delta has initiatives in place to stabilise its costs.

Delta bought an oil refinery a year and half ago in June 2012 to make its own fuel. The company is now operating it to exchange non-jet fuel with jet fuel from companies such as Phillips 66 (NYSE:PSX) and BP (NYSE:BP). Other than that, Delta also operates a fuel hedge program to reduce its price risk. During 3Q13, the hedging provided the company with a gain of $337 million offsetting its fuel costs. I believe these two programs alone could provide substantial cost management provided the company continues hedging effectively and the fuel refinery continues its operation.

The company's EPS was 29% percent higher than 2012's figure. The company reported a $0.36 gain with the final diluted EPS rising to $1.59.

The Future

Delta has some ongoing projects to enhance the company's value in the future. The $1 billion structural change started back in 2012 to bring decrease costs is still in its developmental stage and is expected to provide material results from 2015 onwards. The program includes replacing older aircraft with a new fleet, improve staff productivity and working on distribution channels to increase value.

The company acquired Endeavor as a result of its bankruptcy last year. Endeavor, was already operating nearly 192 aircrafts for Delta along with agreements with Bombardier Airspace, Boeing and SkyWest Airlines. This means that Delta can replace nearly 200 50-seat aircrafts as part of its restructuring plan.

The Bombardier agreement is expected to deliver 28 aircrafts this year. Boeing will provide Delta with 100 new fuel efficient B-737-900ER aircrafts. The first delivery came last September and is expected to continue up until 2018. The lease agreement with Boeing will also bring an additional 36 aircrafts this year and next year. The leased B-717-200 aircrafts carry a 110 passenger capacity and feature fully upgraded interiors with 12 first class and 15 economy class comfort seats along with in-flight Wi-Fi throughout the cabin. This will allow Delta to improve its brand image.

Delta owns Enough Cash to Carry out its Plans

The company will incur $1.7 billion as CAPEX this year and the figure is expected to decline to $1.2 billion in 2015. To determine whether or not Delta possesses enough resources the cash flow statement below provides an overview.

By the end of the third quarter, Delta had $5.8 billion in liquid resources consisting of $4 billion in cash and cash equivalents along with $1.8 billion in undrawn revolving credit facilities. The company generated a CFO of $3.4 billion during the nine months that ended last September reflecting an increase of 79% from the same period in 2012.

This is sufficient to carry the $1.7 billion expenditure this year and can sustain the company in the coming years. The excellent performance of this quarter and the strong prospects ahead are already being reflected in the share price momentum.

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Source: Trefis

Year to date, Delta's stock price has risen 140% to its current price of $31.5. The forward P/E of the company currently stands at 11.2 times that is less than the strongest rival (in terms of sale), United Continental Holdings' (NYSE:UAL) 11.5 forward P/E and that currently makes Delta undervalued.

Conclusion

Although Delta is undergoing a restructuring process the company promises to return $1 billion by the end of the next year to investors either through dividends or share repurchase. Supporting the decision, the company paid $51 million (6 cents per share) in dividends last September. It also repurchased $100 million worth of shares during the last quarter as part of the $500 million buyback program that the company expects to complete by June of 2016.

These plans are convincing enough for me to say that Delta should be a part of your portfolio. Therefore, I conclude this article by giving this company a buy rating.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.