By Jeffrey Flemin
Delta Air Lines Inc. (DAL) operates approximately 700 aircraft in nearly 70 countries, stopping at over 350 destinations. It also operate a private charter business, cargo business, and provides various services to other airlines (aircraft maintenance, repair and overhaul, and security & training services.) Delta has several alliances with international and domestic airlines for marketing purposes. It has codeshares with over a dozen international companies and is a member of SkyTeam, which connects it to even more airlines. This allows reciprocity of air miles and frequent flier programs as well as airport lounges and other perks. Domestically Delta is partnered with Alaska Airlines (ALK) and Hawaiian Airlines, and has service agreements with multiple regional carriers.
A huge concern for any airline is always the price of fuel. Since 2008 Delta has been able to reduce its per gallon average by almost $1 per gallon. According to the 2010 annual report, in 2008 fuel was 38% of its operating expense; in 2010 it was only 30%, even with an increase of 1.1 billion gallons. Delta missed analyst EPS estimates because of rising fuel costs in 2010 Q4, and 2011 Q’s 1 & 2. In 2011 Q3 Delta came in above EPS estimates despite a 42% increase in fuel costs. Fuel will always be a wild card with the airline industry, and unfortunately there is no way to predict prices. More fuel efficient planes and adjusting planes to route demand so they’re flying with fewer empty seats will help reduce fuel costs. In its annual report Delta pledged to do this, and I think the results in Q3 point to some initial successes. Look for more to come in Q4 and 2012.
Competition is significant, as acknowledged by Delta. It should fare a little better with American Airlines parent AMR (AMR) filing for bankruptcy, but until the filing is fully completed, we won’t know the full impact of that situation. Delta is on top of the market with 24.6% market share measured by revenue passenger miles. Behind it is American Airlines with 17%, United Airlines (UAL) with 13.1%, and Southwest (LUV) with 9.7%. The United figure is without Continental added in, which would bring it to 23.5%. It is essential that Delta try to capitalize on American’s woes by getting its loyal customers and possibly some cheap new planes to help beef up its fleet. In July, Delta said it would be retiring older aircraft. This will reduce the older gas-guzzling technologies, plus reduce extra maintenance required to keep older planes operational. Again, it is sticking to its announced goal of becoming more efficient.
In 2010 DAL announced debt reduction measures in addition to other efficiency efforts mentioned above. Over 2012 and 2013 its contractual obligations and debt payments are set to decrease a total of $1.3B compared to 2011. It is making enough money to meet obligations, and even smartly pay off debts early (which it has done this year.) The benefit here is the reduced interest payments, and it also demonstrates management is being smart and trying get its debt down. It also shows that it is better handling growth and expansion using current cash as opposed to taking loans or issuing stock. United currently has $13B in debt to DAL’s $14B. UAL also leads in cash on hand, with $8B to DAL’s $3B. Revenue projections this year also show UAL in the lead by $2B with $36.5B vs DAL at $34.5B. However, UAL is only down 16% from its 52 week high of $27.22, while DAL is down 33% from 13.21.
Both have analysts’ targets over double their current share prices. A key point in favor of Delta is that it's completed its merger with Northwest Airlines (2008) and can now focus on growth and efficiency. United is still working on its merger with Continental and has to focus on making that successful before it can focus on other items. I think this is one area where Delta will have the edge going forward.
As the economy slowly recovers, all the people that have been cooped up because of low funds will be itching to get away on a vacation. Delta needs to work with regional carriers to secure these vacationers. Regional carriers make up approx 21% of Delta’s revenues and help funnel more passengers to their own routes. Delta should have time and man hours to dedicate to securing these agreements and recruiting people that haven’t vacationed lately, while UAL is still working on integrating Continental. In addition, Delta can continue to grow its behind-the-scenes service business. With smaller regional carriers looking to save costs, contracting Delta’s maintenance services is definitely going to be cheaper.
Delta and United will be in a constant battle for #1 and #2 for the foreseeable future, especially with American struggling. Unless fuel costs get extremely crazy, I see no reason why Delta won’t continue to beat estimates and get to its $18.00 price target within the next 9-12 months. Delta’s revenues and profit have been growing steadily over the last three years. The only reason for the stock to be as beat up has it has been is the last four quarters of reporting higher than expected fuel costs hurting EPS. Even though in Q3 fuel costs weren’t as bad as expected, and as a result the EPS was better, investors are fearful, and have beaten this stock up excessively. You could wait for Q4 results to buy, but I think they’ll be at or above estimates, and then you’ll end up having to buy at $9 or $10. Wait for the next down market day, and you should be able to still pick up some DAL at $8 and ride it from there.