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  1. Home
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  3. / Stocks

Delta Is Ready When You Are

Here's why shares of the world's second largest air carrier offers a solid risk/reward as travel trends start to take off.
By BRAD GINESIN
Mar 17, 2022 | 12:55 PM EDT
Stocks quotes in this article: DAL

At the JPMorgan Industrials Conference this past Tuesday, the airlines uniformly reported that the pent-up demand for travel is starting to materialize. The airline industry sees strong bookings and pricing across the board, leading to positive cash flow.

Delta Air Lines (DAL) , the second largest airline worldwide, has one of the top management teams, networks, and operational efficiency in the sector. The stock also offers a solid risk/reward as travel trends continue to improve.

Post conference, Morgan Stanley commented, "We remain bullish on the U.S. airlines as we continue to see evidence of powerful pent-up demand being unleashed. Fuel costs are undoubtedly a significant headwind right now but it appears airlines are able to pass it along with little demand destruction (at this point) though prolonged inflation could become an issue. If geopolitical risks subside, the coiled spring awaits its moment."

Delta's president remarked that with the fading of the Omicron variant, they've "never seen demand turn on so quickly." January air travel had been marred by Covid and weather-related issues, only to return robustly in February and March. Last week, Delta had the highest sales day in its history, a testament to the ramp up in travel trends. Considering the airline operates in 52 countries, with many still feeling the impact of Covid, this seems like a promising indicator.

Rising energy prices have caused more investor angst than an actual impact to profitability. Fuel amounts to around 15% of Delta's operating costs. Thus far, Delta has recaptured these costs from fare increases.

Delta reported positive cash flow in the first quarter, although only profitable in March. The company prioritizes balance sheet restoration, committed to reducing net debt to $15 billion. With its competitive cost structure and industry-leading operational performance, the airline has a great opportunity to fully restore its balance sheet to pre-pandemic levels.

Delta stands to benefit from the return of international and corporate travel. Morgan Stanley believes strong demand could put Delta on a path to earning $7/share in 2024. An industry norm earnings multiple of nine equates to their price target of $63, a 75% potential upside.

Unlike the cruise industry, which had to significantly dilute shareholders through secondary stock sales, the airline sector received government support and survived with mainly debt sales. Since enterprise value will likely be a measure of Delta's recovery, the net reduction of debt will act like the equivalent of a stock buyback. Airline valuations from 2019 aren't overly relevant, but Delta would need to rally around 25% to regain its 2019 EV of around $52 billion.

The risks and challenges facing Delta are clear. Covid waves persistently disrupt the airline industry, especially corporate and international travel, and fuel costs continue to surge. Clearly, investors could grow weary of the uncertainty and further discount the stock. Nevertheless, over the next two years, the potential upside on normalization could fuel 50-75% gains, in our view, a favorable risk/reward, just as airline demand is starting to take off.

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At the time of publication, Ginesin was long Delta.

TAGS: Travel | Fundamental Analysis | Investing | Stocks | Trading | Value Investing | Airlines | Analyst Actions | U.S. Equity

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