There may not be many profitable stocks in this market with low bargain valuations, but Delta Air Lines (NYSE:DAL) is one of the exceptions. In fact, many of the major and regional airlines are trading with forward PE ratios in the single digits. In addition to the low valuation, Delta has competitive advantages with its refinery operations and recognition for customer loyalty.
While I typically write about above-average growth stocks, I occasionally write about low growth dividend stocks as well. Delta's earnings growth is expected to be a little below average in 2020 (consensus). Delta is expected to grow revenue at close to 4% and earnings at about 5% in 2020 as compared to the expected revenue growth of 5.2% and earnings growth of 9.1% for the S&P 500 (SPY).
While Delta's lower-than-average growth could cause the stock to underperform the broader market, the low valuation leaves plenty of room for PE expansion. So, good news in the form of earnings beats, new joint ventures or acquisitions, etc. can have a strong positive effect on the stock. So, it is possible that Delta's stock performs better than average even with low growth as investors look for a combination of value and dividend yield in this phase of the maturing bull market.
Delta's Low Valuation
Any profitable companies that are trading with forward PEs below 10 are something to explore. Delta fits that category with a forward PE of about 6. Here's how Delta compares to its peers:
|Delta||American Airlines (AAL)||United Airlines (UAL)||Southwest (LUV)|
Source: Table created by Author with data from Seeking Alpha
Frankly, all of the large airlines are trading with attractive valuations. Southwest is trading a bit higher, but still well below the S&P 500 valuation levels. The S&P 500 is trading with a forward PE of 18. All of the airlines listed above have plenty of room for PE expansion as their growth continues.
It is nice to see some profitable companies with low valuations in this heated market. The companies comprising the airline industry are a good example of that. The low valuations are a result of the cyclical nature of the industry. The airlines are likely to take a big hit during economic downturns. Therefore, the companies in the airline industry typically maintain lower-than-average valuations (the risk is priced in).
Highest Dividend Among the Major Airlines
One of the attractive features of Delta's stock is that it pays a dividend of about 3.5%. This is a higher yield than the other airlines. Here's how the dividend yields compare:
|Airline Company||Dividend Yield|
|Alaska Air Group (ALK)||2.97%|
|American Airlines (AAL)||2.1%|
|United Airlines (UAL)||0%|
Source: Table created by Author w/ data from Seeking Alpha
Delta increased the dividend every year since 2013. The dividend payments increased by 15% in 2019 over 2018. So, with the company continuing to grow, it would be reasonable to expect another dividend increase for 2020.
Delta generated $8.4 billion in operating cash flow in 2019. Operating cash flow increased by 20% in 2019 over 2018. That's a sizable increase, which gives Delta the flexibility for additional CapEx investments, higher dividend payments, stock repurchases, and paying down debt. So, the company has the resources to grow the business while rewarding shareholders with a growing dividend.
Delta has a competitive advantage with its refinery operations through the subsidiary, Monroe Energy. The refinery operations can help keep fuel costs contained. Fuel costs comprise 18% of Delta's total operating revenue. Fuel costs also comprise 18% of revenue for American Airlines. However, United and Southwest spend 22.5% and 19% of total revenue on fuel costs respectively. So, Delta and American benefit from having the lowest fuel costs.
American Airlines did a good job of managing fuel since it matched Delta's costs as a percentage of revenue. This is probably because American doesn't hedge fuel costs. So, without any significant fuel price spikes within the last year, American was able to benefit. United and Southwest did not manage their fuel costs as well. Southwest probably hedged fuel too much, which led to the higher overall fuel cost as a percentage of revenue.
Delta also has a competitive advantage with its customer loyalty. The company's SkyMiles loyalty program provides incentives for travelers to return to Delta for future flights. Delta also had the lowest cancellation rate among the largest four airlines in the United States in August 2019. Delta benefited from not having any Boeing 737 Max aircraft in its fleet (which were grounded last year due to reliability issues).
Delta has a solid track record of receiving awards over multiple years for various reasons. One example of this was the Wall Street Journal awarding Delta with the "Best Airline of 2019" title. Another example is Delta being awarded as Fortune's Number 1 Most Admired Airline for 8 out of the past 9 years. Business Travel News awarded Delta with the title of being the number one airline for nine years in a row. These are just a few examples. More can be found at the link "receiving awards" in the first sentence of this paragraph.
Delta's focus on quality and reliability led to a tripling in customer satisfaction scores over the past decade. This helps the company attract new customers and encourages customer loyalty for repeat business. The results show in these metrics for 2019 over 2018: total passenger revenue increased 6.3% and loyalty program revenue increased 34.5%, while the operating cost per available seat mile declined by 1.3%.
Investment-Grade Balance Sheet
Delta's balance sheet is far from perfect. On the bad side, the company has total debt of $18 billion as compared to total cash of less than $3 billion. The other weakness is the current ratio of 0.41, indicating that Delta has more current liabilities than current assets. High debt and current ratios below one are typical for the airline industry due to the capital intensive nature of the business.
The good news is that ratings agencies Fitch and Moody's gave Delta investment-grade ratings. This means that the rating agencies believe that Delta has the ability to pay off its debt over the long term. On the positive side of the balance sheet, Delta has 2.26x more total assets than total liabilities for stockholders' equity of $15 billion. The company's strong equity combined with healthy operating cash flow shows that Delta is in great shape to handle its long-term obligations.
Long-Term Investment Outlook
Delta's attractive low valuation sets the stock up for future PE expansion. The company's steady profitable growth can help drive the stock higher from the low valuation level.
Delta's refinery business gives the company a competitive advantage to keep fuel costs contained. Having this subsidiary also gives Delta the flexibility to sell it or to split it off if needed. Delta has been looking for a buyer or partner to run the Monroe Energy refiner. So, we could see a new situation with the refinery operations in the future.
Investors should be aware that the main risk for owning Delta or other airline stocks is that they can perform extremely poorly during economic downturns or times of energy price spikes. Other risks include situations such as the coronavirus (COVID-19) or high-profile terrorist acts, which could reduce consumers' willingness to travel or cause certain governments and companies to restrict travel.
Delta had a series of earnings upgrades over the past three months. EPS consensus estimates increased from $7.10 to $7.47 for 2020. This can help boost the stock as analysts show confidence in Delta's ability to grow earnings.
Analysts give the stock a one-year price target of about $70, representing a gain of about 49%. This looks reasonable since it would take the current PE ratio of 6.5 up to about 9.4 (based on EPS of $7.47), which is still an attractive valuation.
Delta's investment-grade rating and dividend yield can help attract income investors, which can help create demand for the stock.
The 2020s will see the transformation of the economy during the 4th Industrial Revolution. We are also running head first into a wave of demographic and debt driven problems that will need solving. A cautious but forward looking approach will be required to thrive in what could be a lost investing decade for many, much like 2000-2009.
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