Delta Air Lines (NYSE: DAL ) has had a great year, and its leaders weren't shy about saying so at the company's recent investor day. However, a new worry seems to have come into focus for Delta executives. With the company's stock having risen so far in 2013, investors could start to worry that the good times are almost over.
Delta's management team is trying to combat this perception by changing the way investors look at Delta. While Delta will always be an airline, it wants investors to consider it as part of the broader category of high-quality industrial transportation companies. This alternative peer group contains many companies with higher valuations than Delta, which should encourage investors that Delta has more room for share appreciation.
The risk of greatness
Delta's recent success can be seen easily in two charts. First, the company's stock price has surged by more than 150% in the last 12 months due to a combination of strong earnings growth and industry multiple expansion.
Second, this gain has outpaced all of Delta's large-cap competitors like United Continental (NYSE: UAL ) , Southwest Airlines (NYSE: LUV ) , and US Airways (now a part of American Airlines (NASDAQ: AAL ) ). As a result, Delta's market cap is now nearly double that of United and Southwest (American, not pictured here, is a little closer with a market cap of about $19 billion).
United and American are each slightly larger than Delta in terms of revenue, yet their valuations are much lower. Delta has earned its premium due to its higher profit margin, which has allowed it to earn more than twice as much money as its nearest competitor (Southwest Airlines) in 2013.
Still, many investors have started to gravitate toward United and American in the last month or so, betting that they have more upside through future margin expansion. For Delta, the utility of being the best of the airlines is declining; while Delta looks good by comparison, it also risks being held back by its competitors' weaker earnings.
A high-quality industrial transport company?
This is why executives repeatedly used the phrase "high-quality industrial transport" in one form or another to describe Delta at the company's investor day on Wednesday. Delta wants investors to think of it as being part of a larger transportation group that includes railroads, truckers, and package delivery companies. It's not a coincidence that all of these companies have higher earnings multiples than Delta.
Delta will look to back up its aspirations by returning more cash to shareholders through higher dividends and/or share repurchases in the next few years. It also hopes to reassure investors of its stability by reducing its debt and pension liabilities, while limiting capex to 50% of operating cash flow.
Will it work?
Delta is likely to see mixed results in its attempt to earn a higher earnings multiple. First, while the company is not paying cash taxes right now (it has credits for its previous operating losses), Delta will eventually start owing taxes. Factoring in a normal tax rate, Delta is trading much closer to the average of other high-quality transports.
Second, Delta will ultimately face much stiffer competition than most industrial transportation companies due to the nature of the airline industry. Ultra-low-cost carriers are likely to continue growing rapidly over the next decade, making it harder for legacy carriers to fill the "back of the plane".
Meanwhile, American Airlines has vastly strengthened its transatlantic route network by merging with US Airways, and low-cost carriers are likely to continue gradually expanding point to point service throughout the U.S.
Foolish bottom line
Delta Air Lines wants investors to look at it in a different light than other airlines: as a high-quality industrial transportation company. This is a wise strategy for changing the conversation and enabling further share price appreciation.
However, there are limits to how successful this initiative can be. Delta still operates in a highly competitive industry, and has less of a moat than most of the companies it wants to be compared to -- e.g., railroads that own thousands of miles of track and package delivery companies that own large sorting facilities and global delivery fleets.
Nevertheless, Delta shares still have more room to grow as the company continues its run of industry-leading profits over the next few years. The gains won't be nearly as spectacular as what Delta delivered in 2013, but Delta is still a stock worth considering.
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