Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking one high-profile Wall Street pick and putting it under the microscope...
For seven straight years, Delta Air Lines (DAL -0.45%) stock has climbed higher and higher. Even $10 off its highs of July, Delta has still delivered a fivefold increase in value to investors who stuck with it since Buckingham Research recommended buying shares back in October 2012.
But all good things must come to an end -- even Delta's surging stock.
That's the upshot of a new report out of Buckingham this morning, related by our friends at StreetInsider.com, who note that today the analyst has called an end to its long-standing support of Delta and is downgrading the stock from buy to neutral with a $58 price target.
Here's what you need to know.
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Delta's biggest fan
"We initiated with BUY on DAL in Oct 2012 given capacity rationalization across the industry," says Buckingham, "and have been unapologetic since given pre-tax earnings that are up 9-fold (on a 9% pt increase in margins) and that have generated ~$22B in FCF, a source of generous capital returns."
But times, they are a-changing. Yesterday, my fellow Fool.com contributor Lou Whiteman reviewed Delta's Q3 earnings update and noted that despite traffic rising 6.8% year over year, Delta was forced to lower its earnings expectations below what Wall Street has been forecasting. In Q3, Delta projects earnings of $2.25 per share at the midpoint of guidance, versus the $2.27 per share that Wall Street is expecting.
"The culprits are costs," notes Whiteman, "with Delta warning that non-fuel expenses would be up 2.5% year over year -- an increase from initial guidance for a 1% to 2% gain -- due to higher employee costs, weather, and record passenger volumes." And because of these costs, says Buckingham, Delta shares are now "likely to rerate lower for longer" -- not just in Q3, but into "4Q ... annualizing into 2020."
Fear the lumpiness?
But costs aren't Delta's only problem. There's also the looming threat of market oversupply from the reintroduction of Boeing's 737 MAX airplanes into service.
For the better part of a year, Boeing's MAX has been shunted off the tarmac due to concerns over the safety of the airplane's maneuvering characteristics augmentation system (MCAS). This has introduced an artificial supply constraint into the air travel industry, as MAX planes already bought by airlines could not be used, and new MAX aircraft were not bought because they could not be used. Because tight supply on constant demand tends to support pricing, this hasn't been an unmitigated disaster for airlines affected by the MAX grounding. Indeed, last quarter Delta managed to grow its earnings 39% year over year despite the fiasco.
But as Buckingham explains, the date of the reintroduction of the MAX into service (now expected to take place in February or March 2020, although this is not set in stone) is making airplane supply "lumpy." No one's really 100% certain when the plane will be back, when airline capacity might grow again, or by how much, and this combined with "increasing global economic uncertainty" may be hurting "business travel volumes" for Delta and others.
What does seem certain, though, is that airline capacity will increase by some amount, and in Buckingham's view, this means that "pricing next year is going to be challenged," probably squeezing Delta's profit margin.
Going forward, says the analyst, "Margin expansion in our model now falls to margin contraction on 2020 cost and revenue pressures." For this reason, Buckingham is cutting its profit outlook for Delta by 13% next year, assigning a lower target price, and downgrading the shares accordingly.
What it means for investors
Mind you, Buckingham is not going all the way from buy to sell, however. In fact, the analyst's new $58 price target actually implies there's a chance Delta stock could even rise a bit over the next year -- perhaps as much as 9% or 10%. When combined with Delta's outstanding 3% dividend yield, that's not too shabby for a stock like this one, in an economy like this one.
Even if most analysts are wrong about Delta and the company doesn't continue growing earnings at 16% annually over the next five years (the consensus projection, according to S&P Global Market Intelligence), I still see a lot of value in Delta shares selling for less than eight times earnings and paying a 3% dividend.
Buckingham may be downgrading it, but I'm not ready to give up on Delta stock just yet.
