Delta's Past Growth
Since 2013, shares of Delta Air Lines (NYSE:DAL) have soared in price, gaining 37% this year, beating out competitors Southwest (NYSE:LUV), United (NYSE:UAL), and JetBlue (NASDAQ:JBLU). EBIT has increased 93.1% year over year since 2011. Over the past four quarters, Delta has beaten EPS estimates every time, most recently with a positive surprise of 13.80%. Following the turbulence in the airline industry in 2007 and 2008, Delta has emerged the biggest winner. Although trailing both US and American Airlines in revenues, Delta posted an astounding $2.7B in profits in 2013, more than both US and American Airlines.
Despite decreased revenues on account of winter storms causing the cancellation of over 17,000 flights during the first two months of the year, Delta still posted top-line growth of 5% and beat analyst earnings estimates. Had weather been consistent with years past, Delta could have seen an increase in revenue of $90M. When added to the $416M in realized revenues, a growth of 7.2%. Additionally, operating margins increased to 7.9%, up 4.4 points. Delta's long-term goals are to sustain 10-12% operating margins annually, and CEO Richard Anderson expects a June-quarter operating margin of 14-16%. Free cash flow is expected to grow to over $3B by year end 2014, representing a growth of over 10%.
Clearly Delta has been successful over the past few years, outpacing its competitors in almost every metric, but what will drive the company's revenue higher and make DAL a good investment? There are several ways in which Delta plans to continue winning into 2014 and beyond.
Delta will be investing more than $770M through year-end 2016 to upgrade the interior of its carriers, adding power at every seat, slim-line seats with adjustable headrests, updated lavatories, and more efficient galleys. In the short term, Delta will be offering full flatbed seats starting on July 1.
In February, Delta announced a change in its frequent-flier program, which CEO Richard Anderson hopes will revolutionize the industry. Starting in 2015, Delta will reward credit based on the price of tickets, not on miles flown. This change will work out well for business travelers who already generate a significant portion of revenue for Delta. Whether this works out for Delta however, is still to be determined, as many speculate this could cause customers to leave.
Fleet restructuring will replace smaller aircraft with fewer, but larger aircraft. After the Northwest merger in 2008, Delta had 500 regional aircraft. This number will be between 100 and 125 by the end of 2014.
Delta's growing international partnerships will extend its global reach and increase profits. Its transatlantic joint venture with Air France and KLM has been a model for future expansion into international markets. The venture represents 25% of industry transatlantic capacity with a $12B revenue base. Service is offered to more than 100 secondary markets in Europe, Middle East and Asia. Since 2008, transatlantic profit margins have increased 8 points. Delta has a new presence in six of the top ten U.S.-Europe markets through its 49% stake in Virgin Atlantic taken in 2013. In Brazil, Delta has added 24 new markets and increased profitability 19% with its equity stake in GOL. Delta plans to add codeshare flights, expand joint corporate contracting, and capitalize on co-location opportunities, making this venture even more profitable. Since 2011, US-Mexico margins have increased 9 points with Delta's stake in AeroMexico. To further improve margins, Delta will improve schedule connections, launch joint corporate contracts, and start maintenance work at the joint MRO JV facility. These ventures and agreements all show that Delta is well prepared to capitalize on emerging markets in the Asia Pacific region.
Another one of Delta's goals is to capitalize on the New York market, the most lucrative in the US, by building scale and improving the overall product. LHR expansion will create demand from corporate travelers on the largest U.S.-Europe market, and JFK Terminal 4 and LGA Terminals C & D are already undergoing improvements. For the first time ever, Delta is projecting profitability in New York by the end of 2014.
CEO Richard Anderson thinks outside the box, and so far it has worked out well for Delta. Instead of purchasing new aircraft, he chooses to refurbish existing aircraft. While purchasing newer planes would save on fuel costs, Anderson decided to use this money for vertical integration, purchasing a refinery from Phillips 66 in Trainer, PA. Over the past three years Delta's largest expense was fuel. Typically, fuel has been purchased under contracts based on market prices, however, the refinery allows Delta to mitigate the increasing cost of the refining margin. The company also capitalizes on this refinery by exchanging non-jet fuel products with Phillips 66 and BP for jet fuel. The $150M purchase has been met with mixed feelings and results, itself losing $116M last year, but increasing the supply of jet fuel available saved just as much. The refinery turned a profit of $3M for the first time in Q3 2013, and price per gallon dropped by 5.4% that quarter. In 2014, Delta expects that the Trainer refinery will be profitable. Delta executives have also stated that they estimate the purchase will ultimately save $300M annually in fuel costs.
In a presentation on May 6, Delta announced that the March 2014 quarter ended with $9.1B of adjusted net debt, a reduction of $2.6B since year-end 2012, and a reduction of 46.5% since beginning 2009 with $17B in debt. By 2014 delta hopes to have reduced that number $7.0B.
Delta will also be increasing its dividend to $0.09 a share beginning in September 2014, and $2.75B will be returned to shareholders no later than year end 2016.
Delta will continue to win in coming years. Its international growth and Trainer refinery will increase margins, and its improvements to the customer experience will increase revenues. Financially, the company is in great shape. Delta trades at a discount to peers and even though has seen significant growth, is still undervalued. When you factor in debt reduction, an increase in dividend, and $2.75B in shareholder returns, Delta shapes up to continue look like a great investment going forward.
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.