Delta Air Lines Signals Industry Changes Are Real

| About: Delta Air (DAL)

Summary

Delta Air Lines reminded the market that the industry will make the necessary capacity cuts on rising oil prices.

The cheap valuation stand outs based on the level of capital returns.

If you agree that the airline industry has indeed changed, do not pass up the valuation in the sector and especially with Delta.

To anybody that would listen, the airlines have stated repeatedly for the last couple of years that the industry has changed. As the industry has reported unheard of profits over the last couple of years, the rising capacity has brought back fears of the industry of the past.

The news from Delta Air Lines (NYSE:DAL) yesterday reinforces the theory of a changed industry. The smoke screen from lower oil prices has the market focused incorrectly on capacity growth and not profit growth. The following news from the legacy airline on capacity reductions and capital returns are why investors can bottom pick the airline industry stocks.

Capacity Reduction

Most of the airlines spent the Q1 earnings reports trying to comfort the market that capacity cuts would take place in the second half if oil prices rose. The biggest fear remains that rising fuel prices due to higher oil prices would squeeze the profits of airlines that were increasing capacity.

At a presentation on Monday, Delta Air Lines released that the airline plans to reduce capacity during Q4 from the elevated growth levels during the 1H16. Most specifically, Delta plans to remove one percentage point from Q4 capacity due to rising oil prices. The end result should be higher fares and reduced fears on capacity growth.

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This presentation comes a couple of weeks after the airline released that April domestic traffic ASMs (available seat miles) grew by 5.2%. With the RPMs (revenue passenger miles) only growing 4.2%, the load factor took a 0.9 point hit for the mainline. In essence, capacity is growth faster than passengers.

Considering lower load factors are typically bad for PRASMs (passenger revenues per ASMs) and profits, the stock hit near the multi-year lows of $40. The airline had already told the market that the goal was to align capacity growth for rising PRASMs for the 2H16.

The market didn't believe Delta Air Lines, but this is exactly why the stock and the sector in general is imperfectly cheap that I highlighted in my last article.

Massive Capital Returns

The amazing story with the legacy airline stocks is that the conversation on profit margins and capacity growth is taking place at record profit levels. So while the market is debating whether the good times keep rolling along, the airlines are returning billions to shareholders each quarter.

While the market cap is down to $32 billion, Delta plans to increase the annual dividend 50% to $0.81 for a 2% yield. In addition, the airline forecasts using more of the free cash flow to repurchase shares. Delta spent $775 million during Q1 on buybacks and forecasts that along with a $375 million ASR during Q2, the airline will spend an incredible $1.8 billion during the 1H16 alone on reducing the share count.

The end result is that Delta Air Lines is on pace to easily return more than 10% of the current market cap to shareholders providing a large net payout yield. The yield adds the net stock buyback yield to the forward dividend yield.

As the below chart highlights, the stalling stock price over the last couple of year provides a compelling investment as the yield continues to surge.

DAL Chart

DAL data by YCharts

Takeaway

Delta Air Lines remains one of the cheapest stocks in the industrial sector while at the same time making shareholder friendly moves of returning large amounts of capital. The move to reduce capacity in the 2H will help with the goal of reaching PRASM growth later this year that should flip the negativity on the stock and lead to multiple expansion. At a forward P/E multiple of 6, Delta Air Lines is a gift for investors that realize the industry has indeed changed.

Disclosure: I/we 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.

Additional disclosure: The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities. Before buying or selling any stock you should do your own research and reach your own conclusion or consult a financial advisor. Investing includes risks, including loss of principal.