With all the positive news we’ve been seeing in the last six months it almost seems like it might finally be safe to enter the airline industry again. After all, airline companies have aggressively attacked past weakness in areas such as cost efficiency, fuel hedging and streamlined flight operations in order to increase top and bottom line growth. Currently the hot name with support by Wall Street analysts is Delta Air Lines (DAL). With the acquisition of Northwest and with recent rumors about a joint bid for Virgin Atlantic by Air France-KLM (AKH) and Delta, it looks like the firm is firing on all cylinders to go higher. This sounds and looks great on paper. But we have our doubts about the future of Delta and the industry.
Our extensive background in successfully trading names such as Delta Air Lines, American (AMR), Southwest (LUV) and others is the very thing that makes us so leery of the space right now. We won’t deny this is an amazing trading space when looking for volatility but even seasoned traders who hit turbulence more often than not have had crash landings or worse. Investing in Delta now looks fairly risky at best as we see two significant issues that deal with oil price uncertainty and over confidence by Wall Street analysts. These two red flags are making us take a "Pass" on Delta until we see more favorable conditions for the company.
1. Unexpected Turbulence: Fasten Your Seat Belt
When looking at Delta the first thought we have deals with the price of oil and its current level of volatility. Where oil prices stand today and where they may move to tomorrow have huge repercussions for Delta. This one variable has the ability to potentially make or break this airliner. Richard Anderson, CEO of Delta, made this point clear when he stated that “Longer term, we must, like any other energy-intensive industry such as oil companies, utilities and railroads, pass on these higher fuel costs to our customers,” which he stated during a conference call on Jan. 18, 20011. Since Anderson made this statement the price of oil has spiked 6.5% higher over fears of a potential oil disruption due to Libya’s deteriorating internal situation. We doubt this spike in oil prices went over well at Delta considering they have only hedged roughly 36% of jet fuel costs for 2011.
Any more unexpected oil price increases or oil spikes in the market for 2011 (we think this is very likely) is probably going to wreak havoc on the firm. Let’s not forget that the CEO pointed out that the only real option when dealing with the price of oil is to pass on the increased cost to consumers. That may be more difficult for Delta considering the fact that it is ranked near the very bottom in air travel consumer reports, which are conducted by the U.S. Department of Transportation. With a ranking like this we doubt Delta holds much client loyalty and the probability of successfully passing off the cost is low.
The fact that air turbulence when experienced is often unexpected reminds us that oil price volatility is no different and that it can easily crush Delta’s profit margins. We feel that fastening the seat belt and sitting tight by investing in Delta is not the right course of action because it doesn’t even make sense to be on the flight in the first place.
2. Hot Today, Cold Tomorrow
As of right now 12 out of 14 analysts who cover Delta have a Buy rating and or equivalent recommendation. The other two analysts have it listed as a Hold. This means that currently 85% of the analysts are in unanimous agreement and bullish. In a base best-case scenario we can have two more analysts upgrade their recommendation to a Buy and have another 12 analysts reiterate a Buy rating. On the other side of the coin if Delta fails to perform and/or oil prices start to really take off above $100 a barrel and take jet fuel prices with it, then there are 14 analysts with the ability to easily downgrade it. This doesn’t make us feel to warm and fuzzy inside when there isn’t much room for upgrading this firm. But there is plenty of room to downgrade should it not meet the expectations of Wall Street.
We often prefer to find firms that are still somewhat out of favor with Wall Street analysts and in the process of turning around. This gives us a better chance of locking in the “easy” alpha a firm gets when it is upgraded by an analyst. It’s very clear that Delta is currently in the exact opposite position of what we look for. In addition, we don’t feel like playing Russian roulette with analyst ratings and or oil prices given how volatile the Middle East has become.
The only thing that Delta offers is a good degree of volatility moving forward for the extremely risk oriented day trader. Beyond that Delta looks like something that offers too much risk and not enough reward in return. Volatile oil prices, unstable profit margins, the start of a civil war in Libya, and a bullish analyst crowd with room to downgrade make it clear in our opinion why we list Delta Air Lines as a Pass.