The worldwide recovery in travel spending has been incredible. Credit card giant American Express saw spending across its travel and entertainment category grow by 39% year over year in the first quarter as people use their pandemic-era savings to buy plane tickets, hotel stays, and other experiences.
One American Express partner that is seeing a huge tailwind from this spending is Delta Air Lines (DAL 0.08%). The international airline is seeing revenue surge and profit margins expand as people spend money on long-distance flights this year. Shares of the stock are up 44% year to date to $47 but are still off significantly from their all-time high of around $60 set before the COVID-19 pandemic.
The Roaring '20s look to be in full swing, with consumers spending like mad on travel experiences. Does this mean investors are still underestimating Delta Air Lines? Let's take a look.
Strong travel demand this spring
Delta was one of the first stocks to report earnings for the second quarter of 2023, and the report was a beauty. Revenue grew 13% year over year to $15.6 billion, driven by 61% growth in international revenue and 20% growth in loyalty revenue from its American Express partnership.
The Delta loyalty credit card -- which is powered by American Express -- is one of the most popular credit cards in the world and continued to grow its members this quarter. Delta is also seeing strong growth from its SkyMiles loyalty program, which added 3 million new members in Q2, a new quarterly record for net additions.
Loyalty revenue from credit cards comes at a higher margin than customer-ticket purchases, helping Delta achieve a record operating income of $2.5 billion in the quarter, a margin of 16%. The company is also benefiting from lower fuel prices as oil futures prices have trended downward over the last 12 months.
For the full year, Delta is expecting its adjusted revenue to grow at least 17% compared to 2022, which would enable it to hit $53.3 billion in annual sales. Management is guiding for adjusted-operating margins to be at least 12% this year, which would equate to $6.4 billion in operating income just in 2023. Not bad for a company that some thought was headed for bankruptcy just a few years back.
DAL Operating Margin (TTM) data by YCharts.
Are margins sustainable?
The big question for a cyclical stock like Delta is whether these 10%-plus profit margins are sustainable. Surging oil prices or a global recession could hurt travel demand within the next few years. This would likely mean Delta would have to lower ticket prices to keep customer volumes strong, meaning a compressing profit margin.
Delta investors back in 2020 knew this pain all too well. There's no guarantee that Delta won't go through another sharp downturn in its financial results at some point this decade. However, the COVID-19 pandemic and the governmental reactions to its spread seem unlikely to repeat anytime soon, which I think bodes well for Delta's profit potential. The company has generated a positive operating margin every year since 2005 excluding 2020 -- even during the 2008 to 2009 recession -- with many years seeing margins above 10%.
With its high-margin credit card revenue as big as ever, it seems likely that Delta's operating margin will be above 10% more years than not, even though it operates in a cyclical industry.
Valuation is not crazy
As of this writing, Delta stock has a market capitalization of about $30 billion. Compared to its $6.4 billion in projected operating earnings, the stock looks rather cheap. But investors need to remember that Delta still has a sizable debt load that shouldn't be forgotten when doing valuation work. At the end of the second quarter, Delta had over $14 billion in net debt, which brings its enterprise value up to $44 billion compared to its market cap of $30 billion.
Delta should have no problem paying off its debts given how much profit it projects to generate this year. If it can hit its $6.4 billion operating-income guidance, that would put the stock at just 6.8 times earnings -- even when including its large debt pile -- which is much cheaper than the average S&P 500 stock. Even though the company will inevitably have some down years due to the cyclical nature of the airline industry, Delta stock still seems underestimated by investors after surging 44% this year.
