Delta Air Lines Flies to a New High: Will It Head Higher?

Shares of Delta Air Lines (NYSE: DAL  ) hit a 52-week high on Tuesday. Let's take a look at how it got there and see if clear skies are still in the forecast.

How it got here
Like the majority of the airline sector, Delta Air Lines is benefiting from a surge in air traffic as consumers use their discretionary funds to take to the skies, as well as significantly lower jet fuel prices, which are down $0.40 since February. Higher traffic and lower fuel costs are welcomed by any airline company.

Delta is also breaking the mold on what an airline can do to control fuel costs by moving away from simply hedging its fuel costs (a strategy that has proven to be hit-or-miss over the years), instead purchasing a refinery for $180 million from Phillips 66 (NYSE: PSX  ) , the recently spun-off downstream operations of ConocoPhillips. The move, according to some analysts, is expected to save Delta up to $300 million annually on what was $11.8 billion in jet fuel costs last year. It will first, however, need to spend an additional $100 million in funds to get its new refinery up to capacity.

Finally, ancillary fees continue to support Delta's bottom line. According to recently released figures by the Bureau of Transportation Statistics, Delta Air Lines brought in the highest dollar amount, by far, in baggage fees and reservation cancellation/change fees compared to any other airline. Delta notched $1.63 billion of the $5.74 billion the entire airline sector derived from these two fees categories in 2011!

How it stacks up
Let's see how Delta Air Lines stacks up next to its peers.

DAL Chart

DAL data by YCharts.

Although the airline sector is a notoriously poor long-term investment, Spirit Airlines' (Nasdaq: SAVE  ) "charge first, ask questions later" philosophy appears to be working... for now.

Company

Price/Book

Price/Cash Flow

Forward P/E

Debt/Equity

Delta Air Lines N/M 3.5 4.5 N/M
United Continental Holdings (NYSE: UAL  ) 5.3 6.0 4.3 824%
US Airways (NYSE: LCC  ) 10.2 4.0 4.6 2,219%
Spirit Airlines 3.1 5.3 8.7 0%

Sources: Morningstar and Yahoo! Finance. N/M = not meaningful.

The airline sector is a scary investment in any respect, but it really has become a tale of two segments: national carriers and regional airlines.

The national carriers have rigid routes, little chance to pass along price increases to their customer base without the risk of alienating them, and generally high levels of debt. Delta, for instance, has so much net debt that its shareholder equity would be completely wiped out if it were to be liquidated right now. US Airways isn't faring much better with a debt-to-equity of 2,219%, but has benefited very recently from the drop in jet fuel costs. Being the one national airline that doesn't hedge its fuel costs, the move higher is at least semi-understandable. United Continental has struggled to benefit from the supposed synergies it was supposed to experience from its 2010 merger of United Air Lines and Continental and is also coping with a large amount of debt.

Now compare this to the regional airlines like Spirit, which have more nimble routes and flexible pricing policies that load fees on the ancillary end and allow these airlines to reap higher margins. Best of all, Spirit has absolutely no debt, which is almost unheard of in the airline industry.

What's next
Now for the real question: What's next for Delta Air Lines? The answer is going to depend on whether it can prove to investors that it understands the first thing about owning and operating a refinery and if it can compete with regional airlines on ticket pricing without alienating its frequent fliers. Using credit card miles is one perk Delta is employing to keep its customers, but it's going to need to do more if it hopes to keep them coming back.

Our very own CAPS community gives the company a dreaded one-star rating (out of five), with 41.4% of members expecting it to underperform. I am one of the 385 members currently sporting an underperform CAPScall on Delta and find myself underwater to the tune of nine points. But, have no fear, history is on my side.

Over the past decade, not a single national carrier has escaped the bankruptcy bug, and based on their current debt levels, I'm not sure they'll go another decade without a few succumbing to it again. With nearly $10 billion in net debt, Delta finds itself a precariously bad position. Even if the refinery offers the potential to save money, I'm not convinced the company knows anything about operating in the refining space. In short, I remain very pessimistic about Delta Air Lines' prospects going forward.

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Fool contributor Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.

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  • Report this Comment On May 31, 2012, at 7:55 PM, sharkflyt wrote:

    My bet is going to be on Spirit Airlines because the airline has no debt and has been soaring with it's schedule service and delivering a great product. The fact that you have to pay for things is also in your favor. You can tailor your flight and spend what you only need.

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