Delta Air Lines (DAL -0.95%) released its most recent earnings Oct. 10, which beat analyst estimates, and disclosed that its traffic climbed 6.8% globally and 8.3% domestically. Key metrics such as total revenue per available seat mile (TRASM), consolidated unit cost (CASM), passenger load factor, operating margin, and fuel expense all improved year-over-year for the quarter, which led to a 13.1% improvement in adjusted net profits.
Nonetheless, guidance for Q4 was weaker than anticipated, with non-fuel costs expected to rise 2% for the full year 2019, which is substantially higher than the previously forecast 1%. This news caused some trepidation for investors eyeing this cyclical industry that has experienced volatile operating results in the past. But it may have been an overreaction.
Delta has performed well relative to industry peers
In many respects, Delta has been the darling of the airline industry. The company's passenger load factor-a key profit margin driver that measures how full its planes are-increased by 90 basis points to 86.5% for the first nine months of 2019. The improvement compares favorably to the 85.7% aggregate statistic for the industry.
Delta leads large airlines in Return on Equity (ROE) at 33.8%. And, it trails only Southwest (LUV -1.08%) in Return on Invested Capital (ROIC) at 17.7%-due mainly to a net margin that exceeds the industry average by 260 basis points. These figures all indicate an efficient business that is utilizing substantial resources to deliver superior results while expanding.
Despite these bullish signals, Delta's valuation is still moderate compared to industry peers. The stock's 2.71% dividend yield is one of the highest in the industry and 150 basis points above average. The stock's 10.0 price-to-free cash flow, 7.42 forward price-to-earnings, and 0.62 PEG ratio are all in-line with industry averages. Its 7.63 EV/EBITDA is actually cheaper than average.
Clear risks present for Delta
Airlines are cyclical companies, and the Great Recession created substantial operating challenges for the industry. Delta's continued revenue growth will depend on macroeconomic conditions that dictate demand for consumer and business travel. Margins will be at the mercy of personnel costs and oil prices. Expected increases in Delta's salaries have already spooked investors, and oil prices, while not forecast to spike, can be volatile depending on supply.
Delta carries substantial debt, with long-term debt-to-equity of 2.11, and has among the lowest cash-to-debt ratio and current ratio in the industry. But a serious recession could jeopardize its financial health with such a balance sheet, potentially leading to dividend suspension or worse.
Many investors simply avoid airline stocks at this stage of the economic cycle, which has merit. Nonetheless, Delta scores well compared to its peers, and its shares recently got cheaper, so it's an attractive option for anyone seeking industry exposure.