Is it better to buy stock in an airline, namely Delta Air Lines (NYSE: DAL), or buy shares in one of the airplane manufacturers that supply it, like Boeing (BA 3.57%)? Of course, prospects for the two are linked, but there are some critical differences between them, and contemplating them reveals a lot about the investment case for each stock. Here's the lowdown.
The airline or the airplane manufacturer
The two hit the headlines in the summer when Delta placed its first significant order from Boeing in over a decade. The order was seen as a shot in the arm for Boeing and its narrow body workhorse of the skies; the Boeing 737 MAX. However, it also highlighted that both companies' prospects are intrinsically tied to the commercial aviation industry. Boeing does have sizable defense interests too, but the swing factor in its earnings is its commercial airplanes segment.
It's an argument that appears to be reflected in the share price performance over the last five years.
Data by YCharts
Still, it's a mistake to assume the two stocks will necessarily move in tandem, particularly as they have their own earnings drivers. However, it's reasonable to argue that neither stock is worth buying unless the recovery in flight departures continues.
Delta Air Lines
The excellent news is that Delta's recent fourth-quarter earnings presentation was full of positive information on the end demand front. CEO Ed Bastian said he'd "never seen a more constructive backdrop for the industry." President Glen Hauenstein told investors that Delta's corporate survey revealed "96% of respondents [are] expecting to travel as much or more in 1Q than 4Q, led by financial services." Given that Delta's corporate domestic sales (which tend to be higher-margin) have still only recovered to 80% of 2019 levels, there's plenty of room for profitable growth.
Moreover, Hauenstein noted, "Consumer demand remains healthy, with advance booking significantly ahead on both yield and load factor for each month of the March quarter compared to 2019."
If there was a downside to Delta's earnings and outlook, it wasn't from end demand. Instead, the market reacted negatively to the report because of rising costs. Management outlined that there would be $550 million in profit sharing paid to employees. Meanwhile, the proposed agreement with Delta's pilots will result in nonfuel cost per available seat mile (CASM) only declining 2%-4% for the full year instead of 5%-7%, with nonfuel CASM rising 3%-4% in the first quarter of 2023.
The glass-half-empty approach stresses the cost increases and worries about the future risk of further cost pressures down the line. But a glass-half-full approach would emphasize that airlines and aerospace suppliers such as Boeing have struggled with labor availability issues. Furthermore, with a potential pilot shortage looming, it makes sense to have a reliable and motivated workforce to build the capacity to deal with solid end demand.
Boeing is ramping up airplane production
The aerospace giant also has no issue with end demand -- a backlog of over 3,500 737 airplanes at the end of September attests to that. Moreover, if what Delta's management said about the airline industry is correct, then it's likely that Boeing will receive many more orders as airlines build out capacity.
Boeing's challenge and opportunity in 2023 are to work with its suppliers to overcome the supply chain issues, constraints, and labor availability issues that have held back its production ramp on the 737. In addition, Boeing is working through some problematic fixed-price contracts in defense that have caused multi-billion dollar charges.
There's a strong argument that a slowing economy will help Boeing and its suppliers with labor availability issues. The rest is up to Boeing to execute on production ramps in commercial airplanes and work through defense contracts.
There's no guarantee Boeing will do this, and the company has had more than its fair share of mishaps in recent years.
Boeing or Delta Air Lines?
All told, both stocks are attractive. However, there's probably more macro-economic risk attached to Delta (a severe slowdown will quickly be seen in its advance bookings and earnings prospects). At the same time, Boeing is arguably more resistant, as it's more of a self-help story. That said, Boeing won't reach Delta's valuation of 12.2 times management's estimate for free cash flow of (at least) $2 billion in 2023 until 2025 (which would work out to $10 billion in free cash flow with the current market cap at $127 billion).
On balance, I think Delta is the better buy, but it's close. So if you are bullish on the commercial airline industry, then there's an argument for simply buying both and diversifying the stock-specific risk of holding just one of them.
