by Steven Carroll.
While questions remain around the medium term outlook for the U.S. economy, the sun continues to shine for the time being. The airline industry is busy reinventing itself and one carrier is exhibiting a remarkable financial discipline that should be of interest to investors. We look at the jet fuel powering Delta Air Lines Inc. (DAL.N).
The economy’s resilience is all the more impressive in light of this year’s challenges – sequestration and debt ceiling negotiations, Iranian challenges and a volatile oil price, fears over the commencement of Fed asset purchase tapering, a new incoming Federal Reserve chairperson.
New airline realities
The airline industry is bouncing through turbulence once again in the face of a different consumer dynamic and an increased emphasis on value. Many of the luxuries of the past are gone, with passenger grumbles around luggage costs, booking fees, etc. now having given way to stoic acceptance of the new reality.
Delta continues to thrive in this environment, having managed to please both the credit and equity markets in recent years. Free cash flow generation has been used (very sensibly) to pay down debt. Considering the massive industry wide temptation that always exists to continue capital expenditure spending on aircraft upgrades, cabin refurbishments, etc., this is a very welcome change in management behavior. The second chart shows the impact of this capital discipline on the company’s debt.
Avoiding price wars
There are many paths to ruin in an airline investment. It only takes one firm that wants to take market share at the expense of margins and suddenly margins are crushed in an escalating price war. Airline watchers are monitoring the European winter as such a situation seems to be unfolding there. For now, however, the StarMine model scores all point to an attractive investment case for Delta – indeed the company scores in the top 1% for the Val-Mo model, due to its combination of attractive valuation, strong price momentum and increasingly positive sellside sentiment.
From a more fundamental perspective, Delta’s likely to benefit from the distractions facing domestic competitors as the AMR/US Air merger has passed regulatory muster. Combine that with anecdotal evidence of Delta’s market share gains from the Continental /United merger and you’re left pondering an airline that seems to have achieved capital discipline, has management focused solely on execution and operating against a benign economic backdrop.
Airlines traditionally don’t belong in the buy and hold portfolio, but Delta’s short term prospects are intriguing – and the European low cost carriers have shown airlines do have the capability to reward investors over the long term. If you’re willing to accept the volatility and keep a close eye on both industry and Delta management – Delta could be the high-flying exception to the rule.
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