Delta Air Lines' (DAL 0.08%) recent results were intriguing. The stock sold off in the aftermath, and that's understandable, given the disappointing full-year earnings outlook. However, the reasons behind the lowering of guidance might make the stock attractive to investors.
What happened
First, the bad news. Delta adjusted its full-year earnings and free-cash-flow guidance. The headline numbers for the full-year guidance are as follows:
- Revenue growth is expected to be above 20%, compared with prior guidance of 17%-20%.
- The operating margin is expected to be 11.5%, compared to the prior guidance of 12%.
- Earnings per share is anticipated to come in between $6-$6.25, compared to the prior guidance of $6-$7.
- Free cash flow is anticipated to be $2 billion, compared to prior guidance of $3 billion.
In summary, it's a tale of revenue outperforming expectations but profit margins and earnings coming in lower than initially expected. While the earnings guidance is within the previous range, the midpoint is about $6.13, notably lower than the midpoint of the prior guidance of $6.50.
Why earnings and cash-flow guidance was lowered
The reason for these lowered expectations comes from a combination of higher-than-expected fuel costs and higher-than-expected non-fuel cost per available seat mile (CASM). On the second-quarter earnings call, management guided toward a fuel price of $2.50-$2.70 per gallon and non-fuel CASM to decline by 1%-3% for the third quarter. However, both numbers came in significantly higher than expected, with the price of fuel in the quarter coming in at $2.78 per gallon and non-fuel CASM rising 1.3%.
Moreover, management's guidance for the fourth quarter calls for a fuel price of $2.90-$3.20 and non-fuel CASM growth in the range of 0%-2%.
Revenue growth and costs
Two key takeaways from the company's presentation should make the stock attractive, particularly for those seeking a diversified portfolio.
First, management raised its full-year revenue guidance (see headline data above). Delta continues to see strength in its bookings, led by demand for its premium products, which significantly outstripped the main cabin in the quarter. Delta President Glen Hauenstein said on the earnings call, "Domestic paid load factor in our first-class cabins was a record as we continue to advance our premium merchandising and upsell capabilities."
The focus on premium travelers has differentiated Delta from some of the pressures budget airlines have faced recently.
Image source: Getty Images.
Second, the fuel and non-fuel CASM cost increases came from some factors that may prove temporary. It's tough to predict where the price of oil will be in the future, and buying a stock like Delta will interest investors who already have energy stocks in their portfolios, not least to act as a form of hedge. Just as fuel prices moving higher added $400 million in extra costs to Delta's second half, lower fuel prices could take costs out.
Turning to the elevated non-fuel CASM costs, it came down more than expected maintenance costs, which management broke out into three buckets on the earnings call:
- Investment in "fleet health" intended to improve operationally
- "Expanded work scope" on its Boeing 757 planes, an old airplane that's still part of Delta's fleet
- Ongoing supply chain issues that are impacting productivity
Here again, these issues could prove temporary. There's nothing wrong with investing in Delta's fleet, especially if it improves reliability when other airlines are receiving criticism for canceled flights. Moreover, the increased work on the 757s might not be a lasting issue, and the supply chain issues (which have impacted the whole industry) are slowly improving.
Why Delta is attractive for investors
Delta will interest you if you're looking to take advantage of potential lower oil prices and the prospects of an improving supply chain, which will benefit margins in the aerospace industry in the future.
There's always the question of whether higher interest rates will choke off demand and make it hard to pass on increased costs. Still, the fact that Delta raised its revenue guidance and is doing well with premium customers suggests the recovery has legs. As such, Delta stock will suit investors looking to hedge a portfolio rich in energy stocks.
