Initial considerations
It is true that an airline is not a growth stock, however, the particularities of this sector and the good fundamentals, could offer a wide interest to investors as a sector to consider. And Delta Air Lines (DAL.US) could be an explosive example when the corrections are finished.
Deleveraging
During the pandemic, to survive, Delta Air Lines leveraged its balance and assumed a debt of more than $10,000 million. Two years later, the company's profits are beginning to return to pre-pandemic levels. As a result of this resurgence, Delta Air Lines is now focused on reducing its debt. As of the end of the second quarter of this year, Delta had $21.4 billion in long-term debt, which is down from $23.6 billion at the end of 2021. Recently, according to a Wall Street Journal article this month:
"The company is targeting $15 billion in adjusted net debt by 2024, which would mean a reduction of $5 billion in adjusted net debt from today to the forecast date".
Let's look at a summary of Delta's outstanding debt by category as of June 30, 2022:
Paying off debt is obviously important to reduce leverage and free up cash flow, but in an environment where interest rates continue to rise, it's even more critical for the business.
Return of Corporate Travelers
The return of business travel helps the company's efforts to deleverage. The airline industry as a whole is seeing corporate customers return to near pre-pandemic levels. According to the Global Business Travel Association (GBTA), an industry association, global business travel spending is expected to rise 33.8% in 2022.
In another recent survey, 85% of business travelers said they absolutely need to travel to achieve their business goals. Looking ahead a year, more than three-quarters said they expect to travel for work more or much more in 2023 than in 2022.
In American Air Lines' (AAL.US) most recent earnings release, the company reported that its business travel reached 80% of 2019 levels in the first quarter of 2022. The company predicts a 90% recovery in the second half of the year.
Likewise, Delta Airines said that its business travel volumes reached the highest levels after the pandemic. Before the pandemic, business travel represented 31% of Delta's total operating income. During the first six months of 2022, business travel already represented 28.7% of total operating income.
The impact of corporate travel on airline bottom lines cannot be underestimated. Although business travel only accounts for 12% of airline passengers, they pay higher prices than other customers and are typically twice as lucrative, accounting for up to 75% of profits.
Even with corporate travel strengthening, a full industry-wide recovery is not expected until 2026. The biggest obstacles to a full recovery in global business travel are persistent inflation, high energy prices, supply chain and labor shortages and, of course, a down economy.
International travel
Another tailwind for the airline industry is the resurgence of international travel. In November 2021, travel restrictions on most fully vaccinated foreign visitors to the United States were lifted. This action made it possible for many foreign nationals to travel to the US for the first time in 18 months.
Despite this policy change, the industry expects the international demand environment to continue to decline through 2022, with the pace of recovery continuing to lag behind domestic travel.
According to Delta Air Lines in its latest quarterly report, international revenue has lagged behind the recovery in domestic travel, but improved in the June 2022 quarter to recover approximately 80% compared to the June 2019 quarter. , as travel restrictions eased and many countries ended testing requirements. The company said:
"Our corporate clients expressed increased interest and plans to travel internationally in the second half of the year due to the elimination of the pre-departure testing requirement for flights returning to the United States."
Financial goals
Midway through the second year after the pandemic, Delta Air Lines' total operating income was up 94% from a year earlier and 10% higher than in 2019 before the pandemic.
For the remainder of the year, the company expects to generate significant profitability. Fast-forward to 2024, Delta estimates revenue to grow to $50 billion with earnings of $7 per share or more.
If Delta Air Lines meets its 2024 goals, the company would exceed pre-pandemic levels of 2019 and begin a new stage of growth for the company.
Analysis
With business travelers returning and international travel on the rise, Delta Air Lines should be able to grow its revenue by 10% in the next two years. Along with this resurgence in revenue, net margins should also improve to 8%, driven by higher margin and premium tickets from business class travelers.
Regarding its bottom line, the market estimates that profits will grow more than seven times from $599 million to $4,480 million during the same period. This translates to earnings per share increasing from $0.93 to $7.00 per share.
Finally, the P/E ratio should contract from 30x to 10x earnings due to the strong increase in earnings making the stock more attractive to investors.
Below is a table that contrasts Delta's current metrics and stock price with the 2-year estimate:
The combination of the resurgence of international travel and the return of corporate travel bodes well for Delta Air Lines to not only return its revenue and profits to pre-pandemic levels, but begin to outperform them and return the company to sustained profitability. However, we must pay special attention to the fact that the 2-year estimate marks the target after the end of interest rate hikes by central banks, a key agent for investors to return to the market with force.
As The Points Guy's #1 airline for customer satisfaction, Delta could once again be the most profitable airline among domestic carriers, ahead of American Airlines. And this is interesting, but the current context is not the most appropriate.
Technical Assessment
Price action remains negative for the sector and therefore the main downtrend channel (blue) remains the key context. It should be borne in mind that despite the good fundamentals that Delta Airlines recently presented, they show signs of a great recovery in the near future, this is yet to come.
The opportunity cost for the investor remains very high and the risk of entering early could mean taking additional corrections before the rises.
It is possible that the lower end of the stochastic indicator could offer a short-term opportunity with the target at the 38.2% level of the fibonacci structure, supported by the recently developed double bottom at 23.6% of the same structure, but the trend and the time frame continue to go against the interests of the market.
Dario Garcia, EFA
XTB Spain
