Why Delta Air Lines Soared 128% in 2013, and Can It Keep Rising?

Delta Air Lines (NYSE: DAL  ) has been one of the best-performing airline stocks in 2013, with a 128% gain for the year, trailing only Spirit Airlines (NASDAQ: SAVE  ) .

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Margin expansion has been the primary driver of Delta's success this year. The company has fairly consistently posted unit revenue gains outpacing the industry average, while cost growth has abated. This has allowed Delta to grow earnings per share by more than 60% even though revenue growth has remained in the low single digits.

However, Delta may have trouble replicating its success in coming years. While the company remains the strongest of the major airlines, its big 2013 gains leave more modest upside for 2014 and beyond.

The year that everything went right
In many ways, 2013 was the year that everything went right for Delta Air Lines. The company began its streak of unit revenue outperformance in spring 2011, but in that year and in 2012, strong unit revenue gains were often accompanied by big cost increases. In 2012, unit costs rose 6%, following an 11% jump in 2011.

These cost hikes were driven primarily by increases in fuel price and secondarily by higher employee wages. Rising costs fully offset the 10% and 7% unit revenue increases Delta posted in 2011 and 2012, respectively.

Delta has finally seen cost relief in 2013, primarily due to a drop in oil prices earlier this year.

In 2013, Delta's unit revenue has continued to grow, albeit at a more moderate pace. Moreover, unit costs have started to fall. Fuel costs have dropped significantly year to date, due in part to the impact of Delta purchasing a refinery in Pennsylvania, thereby increasing the national supply of jet fuel and reducing the refining premium airlines have to pay.

Meanwhile, non-fuel unit costs have increased just 3% year to date, while non-fuel cost growth dropped to just 1% last quarter. This improved cost discipline can be attributed to Delta's $1 billion structural cost reduction program, which the company revealed at its investor day event in December 2012.

Opportunities and challenges for 2014
Delta has some room for continued margin improvement in 2014. The structural cost reduction program has just started to kick into high gear with the arrival of Boeing (NYSE: BA  ) 717 aircraft subleased from Southwest Airlines (NYSE: LUV  ) . These planes will be much more cost-effective to operate than the aircraft they are replacing -- primarily 50-seat regional jets.

The implementation of Delta's joint venture with Virgin Atlantic should also improve the company's competitiveness in New York, where it will now take a strong No. 2 spot for flights to London's Heathrow Airport (a critical business market). This should drive some further unit revenue gains in New York.

On the flip side, oil prices have been on the rise recently, so Delta may not benefit from the same cost decreases that boosted earnings in 2013. Additionally, the company's ongoing battle with Alaska Air (NYSE: ALK  ) in Seattle and Salt Lake City will probably be a drag on earnings, though Alaska will bear the brunt of the damage. Lastly, from an accounting perspective, Delta will need to start accruing income tax in 2014, which will lead to lower reported earnings.

Adding it up
Today, while Delta is a reasonable investing opportunity, it has much less upside than it did at this time last year. In all likelihood, the company will produce some pretax margin growth in 2014, but earnings per share will fall due to Delta's need to accrue taxes. With this in mind, there are more promising stocks in the airline sector today.

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  • Report this Comment On December 31, 2013, at 5:33 AM, DalePlourde wrote:

    Sometimes Motley Fool's articles as in this case, not aligned with the financial fundamentals and facts. Delta Airlines is one of the most undervalued companies in the S&P 500. Delta's shares and multiple have much more room for growth, with a forward PE ratio of 9.03 compared to the industry average PE of 20.72 in Q3. At the last investor day Dec. 11, CEO Richard Anderson emphasized Delta's commitment to innovation and creativity as fundamental growth driver's at Delta, ie. buying their own refinery was innovative giving the company a competitive advantage. As well Delta in very innovative ways is reducing their carbon footprint and incorporating recycling throughout the company. Edward Bastian guided for record pretax 2013 profit of 2.6B, as well as EPS growth between 10-15% for 2014 with topline revenue of 40B for 2014. This combined with increased capital returns to shareholders via new dividend, and buybacks, Delta at it's current price range of 26-28, is a smart buy. I will be holding my shares into earnings, as especially as Bastian said fuel prices were set for 3.03-.3.08 per gallon (the Dec jet fuel high is/was 3.03) profits for Q4 could be higher than guidance. Strong guidance has already as mentioned been provided for 2014.

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