Will Delta Double Again In 2014?

| About: Delta Air (DAL)

Executive summary:

  • Delta Air Lines performed the best out of the major U.S. airlines this past year.

  • While expensive, Delta's flights are worth the price.

  • Excellent services and a cheap valuation will send Delta higher in 2014.

  • While Delta is not likely to double in 2014, Delta should move 16.6% higher to a price of 37.13.


Excellent Services

The past year marked an excellent year for U.S. airlines. Of the three largest U.S. airlines (Delta Air Lines Inc. (NYSE:DAL), United Continental Holdings Inc. (NYSE:UAL), and American Airlines Group Inc. (NASDAQ:AAL)), Delta led the way with a 114% gain. American Airlines, formed when American Airlines and US Airways merged, has gained 42% since the new airline went public. To compare the cost of a round trip, nonstop flight for one passenger on the three airlines, I will be using the three most-traveled domestic air routes. The three routes are New York to South Florida, Los Angeles to the Bay Area, and Atlanta to South Florida. I will use Monday morning and Friday afternoon as the departure and return dates as they are the two busiest times for air travel. The flights will be "booked" on a Thursday night. All data used below was obtained from Delta's, United's, and American's website.

Group leader Delta excels with its services. Delta's services need to be good for customers to pay up for Delta's flights. As the chart I created above shows, Delta's flights are consistently more expensive than the same option on American or United.

Delta's product line can be broken down into two main categories, in-flight services and pre-flight services. Delta offers four different levels of in-flight services. The first tier is called Business Elite. Business Elite is the most expensive and luxurious of the four seating options. Before boarding, passengers in Business Elite have full access to both Delta Sky Club and Delta Sky Priority. Delta Sky Club offers complimentary food and Delta Sky Priority puts Business Elite passengers at the front of boarding and baggage claim lines. During the flight, Business Elite passengers choose a chef-prepared complimentary meal from fully reclinable seats. Each seat comes with a full-size pillow and duvet. Also, every seat is equipped with a personal entertainment system, a USB port, and an electrical outlet. Although the price for Business Elite may be much greater than the other options Delta offers, the increase in price is worth the increase in comfort. The next seating section is first class. Although first class passengers don't have access to Delta Sky Club, they do have access to Delta Sky Priority. In-flight, first class customers receive either the complimentary meal or a large snack, depending on the length of the flight. First class passengers also have an entertainment system, a USB port, and an electrical outlet. The third level of seating is Economy Comfort. Economy comfort, in comparison to economy, includes extra leg room, better seat location, Delta Sky Priority, and complimentary drinks. The last level of travel is called as Economy. The large variety in price and comfort of the four different sections allow the airline to appeal to a wide pool of potential customers.

Delta's pre-flight services, outside of Delta Sky Priority and Delta Sky Club, are just as impressive as the in-flight services. The pre-flight services have two main goals. The objectives are to create the easiest possible way for customers to book flights and check-in on upcoming flights. Delta attempts to address the first objective with technology. On Delta's website, customers can view flight schedules, important travel tips, check-in, and change or refund a ticket. Better yet, Delta's mobile app provides customers with the same facets offered on the website.

Delta has created an economic incentive for their customers to return by establishing a rewards program. Customers can create a Skymiles account and are rewarded based on the number of miles they travel with Delta. Rewards include discounted or free flights, depending on the number of miles a customer travels. In addition to the Skymiles reward system, Delta has an extension to the rewards program known as Crossover Rewards. Delta has teamed up with Starwood Hotels and Resorts Worldwide Inc. (HOT), a lodging company that owns many recognizable hotel chains, to create Crossover Rewards. Members of Starwood's rewards program receive bonus points for flying with Delta and members of Delta's Skymiles program receive bonus miles for staying with Starwood hotels.

Cheap Valuation

Delta is cheap relative to the market and to its two major competitors. The table I created below using data from finviz.com highlights Delta's cheap valuation relative to the market.

Delta's cheap valuation relative to the market hints toward further gains as Delta has more room to run before it is no longer considered an undervalued stock. The graph I created below using data from finviz.com shows Delta's valuation relative to its competitors, American and United.

Price Target

I reached my price target of 37.13 by taking the weighted average of five different scenarios. The five different scenarios were created using data from Trefis.com. All five scenarios offer a bright outlook for Delta. I chose to have all scenarios offer a bright view because I believe Delta will move higher due to a cheap valuation and excellent services. Debt was kept constant for all seven models. The Trefis model is based on the belief that:

"the value of a company is the sum of the values of its divisions, plus cash, minus debt."

The table below shows where the five different valuation methods set Delta's price. The table uses EPS for each section.

For scenario one to happen I kept fuel prices, available seat miles, average occupancy rate, and other divisions constant while increasing Delta's U.S. market share by 2.5% and passenger yield by 5%. The first scenario occurs if Delta's U.S. operations increase by 25% more than expected (6.03 EPS). For scenario two to happen I kept fuel prices, available seat miles, average occupancy rate, and other divisions constant while increasing Delta's international market share by 1.5% and passenger yield by 6%. The second scenario occurs if Delta's international operations increase by 19.5% more than expected (3.1 EPS). For scenario three to happen I kept fuel prices, available seat miles, and other divisions constant while increasing Delta's regional average occupancy rate by 5% and passenger yield by 8%. The third scenario occurs if Delta's regional operations increase by 14.2% more than expected (1.47 EPS). For scenario four to happen I kept extra baggage, ticketing changes, and other divisions constant while increasing Delta's freight and mail revenue by 8%. The fourth scenario occurs if Delta's cargo and other businesses increase by 1.6% more than expected (.32 EPS).

Scenario five, unlike the previous four scenarios, assumes that more than one division can increase operations in 2014 by more than the expectations. The factors kept constant in scenario five were fuel prices, average seat miles, extra baggage, ticketing changes, and average occupancy rate. The factors increased in scenario five were all (regional, US, and international) passenger yields by 3%, all (regional, US, and international) market shares by 2%, and freight revenue by 5%. Scenario five happens if US operations increase by 19.8% (4.79 EPS), regional operations by 4% (.41 EPS), international operations by 21.3% (3.4 EPS), and cargo by 1.5% (.3 EPS). Therefore, scenario five represents a total increase of 29.8%. As the scenarios show, US operations will be crucial to Delta's success in 2014. To reach the 16.6% upside that I forecast for Delta, I took a weighted average of the five scenarios. Scenario five was weighed 20%. The first four scenarios were weighed 4/5 of what percent of share price the altered division in each scenario counts for. The calculation can be seen below.


While Delta will not double in 2014, as it did in 2013, Delta should move 16.6% higher to a price of 37.13. Such performance can be expected from Delta due to excellent preflight and inflight services and a cheap valuation. Investors can get long Delta by buying shares of common stock or by purchasing call options.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: Lionfin Capital is a group of investors.