Delta Earnings: Can This Airline Keep Flying High?

Matthew is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Delta Air Lines (NYSE: DAL) has come a long way since emerging from bankruptcy in April 2007.  The company has taken extensive measures to make itself run more efficiently. It is once again profitable and is expected to grow its earnings considerably over the next several years.  However, the company is extremely cheaply valued right now, indicating that the market is still skeptical that Delta’s business model will be able to deliver over the long term.  With the company set to report earnings on Jan. 22, investors will be listening for signs that Delta is indeed on the path to sustainable success.

 

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Shortly after emerging from bankruptcy, Delta announced and completed a merger with Northwest Airlines, and combined both airlines into one operation.  The lower crude oil prices of the last few years have indeed helped Delta, as well as the gradual transition to more fuel-efficient aircraft.  Combined with the increased fees Delta and other airlines have begun collecting (inconvenient if you are a traveler, but nice for investors), the airline has once again begun to turn a profit after a rough couple of years in 2008-09.

 

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One of the most innovative steps Delta has taken to run more efficiently is their recent agreement with Phillips 66 (NYSE: PSX) to buy the Trainer refinery complex near Philadelphia for $150 million.  Delta is planning to spend an additional $100 million to convert the facility to maximize the production of jet fuel.  According to industry analysts, this should lower Delta’s fuel costs by approximately 10% beginning in 2013. I would expect Delta to provide an update on this project during the earnings call. Fuel costs are the largest expense for an airline, and this could prove to be an enormous competitive advantage going forward. 

The airline industry itself has been doing much better by streamlining operations and improving efficiency.  After the Northwest merger, Delta is the largest passenger airline in the world. In the U.S., the airline industry consists of 20 commercial airlines with revenues of over $1 billion.  Delta’s closest competitors include American Airlines with a 17% share of the U.S. market, United and Continental Airlines with a 23.5% combined share (NYSE: UAL), investor favorite Southwest Airlines (NYSE: LUV) with a 9.7% share, and U.S. Airways (NYSE: LCC) with a 7.5% share. 

In terms of valuation, Delta appears to be very cheap right now, but there is a lot of uncertainty regarding Delta’s ability to deliver on expectations.  Delta currently trades at just 7.3 times projected 2012 earnings, which is extraordinarily low considering the earnings growth expected.  Consensus estimates call for earnings of $2.52 and $2.85 in 2013 and 2014, respectively, a 57% increase in a two year period.  In other words, Delta trades at only 5.3 times forward earnings.  One thing holding down the valuation is the level of debt carried by the company. Delta currently has $11.3 billion in long-term debt and only $3.6 billion in cash, for a net debt of $7.7 billion, rather large considering the $11.3 billion market cap of the company.

However, I believe the low valuation is not due to debt, which is certainly manageable given the company’s high level of revenues, but due to uncertainty. Delta will not trade at a higher multiple until it proves to the market’s satisfaction that it can grow its earnings and, more importantly, that it can sustain profitability over the long term.  Any indication that things are on the right track for Delta, especially in regards to its cost-cutting measures, would do a lot more for the share price than the earnings numbers themselves will. 


KWMatt82 has no position in any stocks mentioned. The Motley Fool recommends Southwest Airlines. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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