It's been a difficult few years for the airline industry, and Delta Air Lines (DAL 0.62%) hasn't been spared any of it. The pandemic and resulting travel restrictions savaged the industry, and it's still recovering. Meanwhile, a host of challenges, including labor shortages, rising fuel costs, supply chain constraints, and ongoing travel restrictions, impacted the industry in 2022. Still, despite a host of challenges, the stock looks like an excellent value right now.
What Wall Street is worried about
Like much of the aerospace and hospitality-related industries, Delta's management benchmarks its performance to 2019 -- the last year before the pandemic hit. It's a useful yardstick because it helps highlight the point that the airline industry has growth prospects from merely catching up to pre-pandemic demand levels. That's a critical consideration because many investors in a highly cyclical industry like airlines conclude that a slowing economy means airline stocks are a sell.
NYSE: DAL
Key Data Points
Indeed, the negative thinking appears to be baked into Wall Street analysts' estimates for the airline. For example, on Delta's financial outlook and strategic update in mid-December, management called for earnings per share (EPS) of $5 to $6 for 2023 and then for more than $7 in 2024. Meanwhile, the Wall Street consensus is for $5.20 in 2023 (at the low end of the $5 to $6 range) and $6.89 (below management's estimate). It appears that Wall Street doubts Delta's ability to overcome cost pressures and the risk that a slowing economy will hit the company's revenue generation.
Catching up with 2019
However, as management noted during the December update and on its recent fourth-quarter earnings call, there's reason to believe that merely catching up with 2019 will generate growth. For example, Delta's flight departures in 2022 were only 81% of 2019 levels, and available seat miles (ASM) were only 85% on the same basis. Delta plans to have ASM up to 101% of 2019 levels by the summer, with departures up to 86% of 2019 levels.
The all-important corporate traveler (who tends to be higher margin) also has room to grow. According to Delta president Glen Hauenstein on the earnings call, corporate domestic sales were 80% recovered to 2019 levels in the fourth quarter. CEO Ed Bastian described the current industry backdrop as the most "constructive," he'd ever seen. Hauenstein also noted that advance bookings were "significantly ahead on both yield and load factor" for the quarter ended March 31 compared to the same period in 2019.
There may well be a slowdown coming, but it certainly isn't being seen in Delta's data yet, and there's still ample room to grow by catching up to 2019.
Delta Air Lines's cost concerns
The cost pressures alluded to earlier will seep into 2023, with management expecting its nonfuel cost per available seat mile (CASM) to increase by 3% to 4% year over year in the first quarter. However, it expects overall nonfuel CASM in 2023 to decline by 2% to 4%.
As such, the operating margin is forecast to recover to 10% to 12% in 2023 from just 8% in 2022 -- a sign of how severe the cost pressures were. For reference, the average operating margin from 2015 to 2019 was 14.5%.
With a labor agreement reached "in principle" with pilots, Delta should be over the worst of its labor cost issues, and as the airline builds scale (more departures and ASM), the CASM should decline.
Delta Air Lines is a stock to buy now
Delta Air Lines has an opportunity to grow revenue, grow margin, and benefit from a return of the higher-margin corporate traveler. Embedded in management's forecasts is an expectation for $2 billion in free cash flow in 2023 and $4 billion in 2024.
With a market cap of just $24.5 billion at present, if Delta hits those targets, then the stock will look very cheap, even for a cyclical company.
There are, of course, headline risks. There's no guarantee that cost issues won't extend, and a severe economic slowdown will hit the travel industry. Still, on a risk/reward basis, Delta looks like a good value, even if it's likely to be a bumpy ride through 2023.
