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We are recommending a Buy rating on the shares of Delta Air Lines (DAL), with a price target of $50 per share, roughly nine times forecast 2023 earnings per share. The company delivered strong third-quarter results and struck an upbeat tone on their earnings call.
Company and industry overview
Delta Air Lines (NYSE: DAL) and its 80,000 employees operate a fleet of over 800 aircraft to more than 275 destinations worldwide. Delta’s major U.S. hubs include Atlanta, Boston, Detroit, Los Angeles, Minneapolis-St. Paul, New York-JFK and LaGuardia, Salt Lake City, and Seattle, at most of which it is the dominant player. It also has a strong presence at a number of international gateways via alignments with a string of airline partners, including but not limited to Aeromexico, Air France-KLM, China Eastern, LATAM and Virgin Atlantic. It is, depending on the metric utilized, either the largest or second largest airline in the U.S., and one of the world’s largest overall:
| Airline | Revenue Passenger Miles (billions) | Available Seat Miles (billions) |
| American Airlines | 165.0 | 212.6 |
| Delta Air Lines | 140.8 | 186.3 |
| United Airlines | 130.9 | 177.7 |
| Southwest Airlines | 115.2 | 143.2 |
| Rest of Industry in United States | 200.0 | 259.2 |
Source: U.S. Department of Transportation, 12 months ended q1 2022
Despite its lower capacity, Delta has managed to more or less keep pace with American in terms of top-line performance and is consistently the most highly-rated U.S. major airline in terms of customer satisfaction and service. The top four U.S. airlines account for approximately three-fourths of air traffic, an oligopoly situation which, while not devoid of competitors, provides them a significant competitive moat.
Delta has performed admirably in spite of the incredible challenges posed by the COVID-19 pandemic. It is unique amongst the U.S. major airlines as the only one not to issue any equity or convertible debt during the crisis. Instead, it employed a proactive, unprecedented capital raising exercise highlighted by the issuance of a staggering $9 billion in bonds and loans backed by its SkyMiles loyalty program plus additional debt capital raises and sale-and-leasebacks of billions of unencumbered aircraft. They’ve also capitalized on the dislocation in the market for commercial aircraft to acquire used Airbus A350 and Boeing 737 aircraft on attractive terms to complement their existing fleets of each type and have recently taken significant measures towards reducing their debt burden as well.
Delta shares are down about a third from their post-COVID highs reached in early 2021 and over 40% from pre-COVID highs. While fuel costs have risen dramatically since then, the prospects for a sustainable recovery for Delta and the sector at large have become far clearer in recent months, but this has not translated into share prices. The market may be skeptical of Delta’s recently released forecast as well as the impact that may come from the uncertain macroeconomic environment. Despite these concerns, it’s fair to say that at a single-digit multiple of earnings assuming a run rate consistent with the second half of 2022, and with capacity still meaningfully below 2019 levels, there appears to be a wide margin for error for the company going forward.
Financials and projections
Delta’s third quarter earnings contained various positive signs, including record third-quarter revenues and unit revenues in the form of TRASM (total revenue per available seat mile) up an impressive 23% on an adjusted basis from the same quarter in 2019. Profitability was constrained by the inflationary pressures in the market, most notably the surge in fuel costs, but this performance is still encouraging as Delta operated at capacity of just above 80% of 2019 levels. They also achieved double-digit operating margins which they will look to continue to boost in future quarters. In addition, the airline provided its outlook for 2024, which is ambitious but should excite shareholders nonetheless:
Source: Delta Air Lines
They are aiming to fully restore their capacity by the summer of 2023, though they will be able to adjust capacity to meet demand and have significant financial flexibility should demand not increase as they expect. The following table plots our estimate of 2023 earnings at different levels of growth in yield relative to 2022 levels, as well as passenger load factor (RPM/ASM), that 2023 capacity will approximately equal 2019 levels:
| 1.0% | 2.0% | 3.0% | 4.0% | 5.0% | |
| 85.0% | $3.07 | $3.64 | $4.20 | $4.76 | $5.32 |
| 86.0% | $3.74 | $4.31 | $4.87 | $5.44 | $6.01 |
| 87.0% | $4.41 | $4.98 | $5.55 | $6.13 | $6.70 |
| 88.0% | $5.07 | $5.65 | $6.23 | $6.81 | $7.39 |
| 89.0% | $5.74 | $6.33 | $6.91 | $7.50 | $8.09 |
Source: Author’s own calculations
Based on the above table, we expect Delta to ultimately guide to at least $5 in 2023 earnings per share, and possibly $5.50+. The company is very focused on growing the share of premium and other revenue from the approximately 54% level that it currently sits to closer to 60% by 2024. They’ve already made significant strides in increasing unit revenues for both the domestic and international business and as airlines globally restore their capacity, both the loyalty and MRO businesses should see gains as well.
An investment-grade risk profile
Management highlighted during its earnings call that it has a target of restoring its investment-grade rating by 2024, with its guidance on debt ratios and operating margins falling squarely in the Baa category from Moody’s rating methodology for passenger airlines. This seems feasible, and while Delta will have to balance this goal with its profitability targets and compensation for shareholders, the already substantial reduction of debt should be viewed as an encouraging sign for shareholders that the company is on the right track.
Capital allocation
Based on excess capital forecast to be generated by the business, it is not a reach to see dividends and/or buybacks reinstated in the not-too-distant future. Management’s emphasis on returning to an investment-grade rating profile may minimize the size of shareholder returns over the next few quarters. However, provided that the business performs as expected and the company is able to greatly increase profitability while reducing its debt load, the potential for meaningful returns of capital over time will exist for patient shareholders.
Risks to investment thesis
Economic recession
Though recession may be the end result of Fed tightening, a garden variety recession would likely pale in comparison to the impact of the pandemic on the airline industry. The fact that unit revenues are up so strongly despite the macro backdrop should be taken as a very encouraging sign, as the airline is still operating meaningfully below pre-COVID levels. In addition, there is increasing evidence that the “new normal” of remote work has further solidified the demand outlook for U.S. carriers throughout the year. Delta’s substantial liquidity and capital markets access should allow it to weather macro issues.
Pilot / labor shortage
A potential concern for Delta, and the U.S. airline industry at large, remains the need to hire additional pilots and staff to return the industry to pre-COVID traffic levels and beyond. During COVID, many airline staff were furloughed and others elected early retirement based on offers provided by their employers. This is a very well-known issue, however, and Delta is already operating sufficiently close to 2019 levels that it does not require a massive boost in headcount to at least return to these levels, which it has projected that it will be able to do by summer 2023.
Elevated fuel prices
There is some chance that fuel prices remain high or even increase from recent levels, which would result in substantial additional expenses for the company. Delta is partially insulated from this by its refinery ownership, but far more important than the refinery is that rises in fuel prices not be too sudden. The record unit revenues that Delta and others are achieving in the current environment is a testament to the fact that the industry is able to pass through cost increases in the form of higher fares. An oil market shock event, whether economic, geopolitical, or otherwise, would test the resilience of the sector. In addition, U.S. carriers do not have to contend with the currency mismatch related to fuel and debt costs being in U.S. dollars that so many of their foreign peers must overcome. Finally, the fact that the airline has ordered a significant quantity of next-generation aircraft will, all else equal, serve to reduce its fuel CASM.
Interest rates and inflation
Delta’s current debt load is approximately 83% fixed rate which should at least partially insulate it from the rise in interest rates that has occurred over 2022. It also may provide the company with additional opportunities to buy back debt in the market, via tender offer or otherwise, to accelerate its liability reduction goals. We’ve assumed an additional $2 billion of debt repayment in 2023-24 on top of the obligations for repayment of approximately $5.6 billion over that time.
Conclusion
Delta trades at an inexpensive multiple of current and near-term forecast earnings. The company has an Investor Day scheduled for December 14 during which they’ll provide clearer guidance for 2023 and perhaps an update on their views for 2024 as well. We expect that they will guide to at least $5 per share in 2023 earnings, which would imply a forward multiple of only seven times today.
Should the company meet or exceed their 2024 guidance of $7 in EPS, which seems feasible, that should be sufficient to propel the stock higher over time. A price target of $50 equates to roughly nine times 2023 earnings, which still seems to be a bit on the conservative side, as in addition to the leap in earnings from current levels, the company should have a substantially healthier balance sheet as well.
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