yet another Corporate update From Delta Airlines (New York Stock Exchange:DA), shareholders are still facing stuck shares in the doldrums. The market still fears the worst of the aviation sector that is set Achieving significant profits and cash flows in the coming years. Mine investment thesis Still very bullish on stocks and the aviation sector in general.
Boom times are just beginning
The market appears to be missing Delta’s now expectation to produce 22 second-quarter revenue matching 2019 levels while overall capacity has been reduced to just 82.5% from 2019 levels. The airline continues to easily eat higher fuel prices while producing strong margins.
Delta was guided by a fuel cost jump another 10% to 15% above the previous quarter presented along with its Q1 earnings report in late April 22. At some point, the market will have to realize that airlines are much better operators in the past few years. Many people want to forget that the government shut down all avenues and reasons for travel causing huge financial damage, not bad operating models from airlines.
The legacy airline now draws with an operating margin of 13.5% on revenue of $12.5 billion. Delta would generate up to $1.7 billion in operating income under this scenario in a still challenging environment with significantly lower capacity and higher fuel costs.
Regardless, the airline is making huge profits and cash flow in a challenging environment. Investors should not worry about a possible small recession in the near future.
What is the market waiting for?
As China continues to engage in coronavirus-related lockdowns and fears over monkeypox, the market is naturally wary of being too aggressive on airline stocks. Regardless, investors need to understand that an airline like Delta is not in any financially worse position financially than it was before the covid shutdown of airline passenger traffic.
Delta now has net debt of $15.6 billion, up from levels below $9.0 billion headed to Covid. A company with an additional $7 billion in debt isn’t much different than it was before covid as the airline is on track to generate $50 billion in annual revenue.
The big key to higher valuations will likely be a quarter or two as the airline pays off net debt. Delta does not have a higher number of dilutive shares outstanding to affect share prices, so the equity equation is not materially different now. The airline expects to spend $1.2 billion on capital expenditures this quarter in what should provide surplus cash for initial net debt reductions.
Of course, the big key to unlocking value in airlines is for Delta to get a market multiple of the shares. Analysts are already expecting the airline to reach $6 + EPS next year to come close to levels originally projected for 2020.
Amazingly, Delta is trading at just 6.6x its EPS targets for 2023. Not only has airlines trading near the 10-fold multiplier in prior periods, but industrial transportation stocks have also continued to capture more forward price/earnings multiples. Market type like United Parcel Service (UBS) at 13.5x and Union Pacific (UNP) an average of 17.1 times.
Stock up to the UPS multiplier will nearly double that of Delta shareholders from here. Note that this will only be the beginning with analysts predicting earnings per share of $7.52 in 2024. Continuing this multiplier on 25% EPS growth in 2024 will push the stock above $100.
The airline still needs to generate cash flow to start the debt repayment process. Booking numbers indicate that this will indeed be the case during the summer months, but another variable of the Covid virus could always reduce travel levels again.
The takeaway for the major investor is that Delta Air Lines is very cheap here despite the company’s other strong modernization. The airline sector cannot get any traction due to irrational concerns about the impact of rising fuel costs and future recession.
The ultimate solution is for Delta to start paying off debt with cash flow while still investing in new equipment. The market will eventually pick up and give the market type a price-to-earnings multiplier per share similar to other strong industrial transport stocks.