Earnings season is upon us once again. One of the first stocks to report every quarter is Delta Air Lines (DAL +0.18%), one of the largest airlines in the world. Generating tens of billions in revenue across the globe, Delta Air's financial health gives investors a great read on the travel industry and the general health of consumer spending.
This quarter, investors are looking pessimistically at Delta Air stock. Despite the company growing revenue and earnings in 2023, shares fell close to 10% the day after its earnings release, likely due to disappointing 2024 guidance for free cash flow. Delta stock now trades at a dirt cheap forward price-to-earnings ratio (P/E) of 6, which is well below the S&P 500 average. Does that mean the stock is ready to take flight in 2024?
Fully recovered from the pandemic, minimal exposure to Boeing
2023 was the year Delta Air fully recovered from the COVID-19 pandemic. Revenue was $58 billion for the year, well above its pre-pandemic levels and up 14.6% compared to 2022.
Profit margins look strong, too. Even though Delta and other airlines are facing cost pressures from its employee unions and a pilot shortage, its operating margin was 9.5% in 2023, which equates to $5.5 billion in operating earnings. While this is good news, Delta's operating margin has been much higher in the past. For example, in 2016 it posted an operating margin of 17.5%. If Delta had a 17.5% operating margin in 2023, its operating income would have been over $10 billion.
So what has investors pessimistic? Well, there is general pessimism about airlines due to a potential for a recession in the United States, with the pandemic mayhem in the back of everyone's minds. But there is also the concern with aircraft manufacturer Boeing, which had another incident with its 737 Max aircraft as a door plug blew out in flight on an Alaska Airlines flight. This is another bullet point on a long list of worries for Boeing's products, which could restrict supply growth for airlines.
Luckily for Delta, it has minimal exposure to Boeing compared to other U.S. carriers -- Airbus is its main manufacturing partner. While it is still waiting on a huge backlog to get more aircraft supply flying around the world, Airbus has had much better success than Boeing over the last decade, which should be good for its largest customer, Delta.
A hidden profit driver: Credit cards
On top of selling airline tickets, Delta Air is one of the largest credit card issuers in the world. These cards -- along with its loyalty program -- keep customers locked in with Delta and produce high-margin payments revenue. Its partner is American Express, which runs the payments infrastructure and lending for Delta's credit cards.
In 2023, Delta received $6.8 billion in revenue-sharing payments from American Express, or 11.7% of its overall revenue. Next year, it is guiding for credit card revenue to grow 10% year over year and make up an even larger portion of the business. This should remain a growth driver for Delta over the long term and can help it expand margins if the segment becomes a larger part of the consolidated business.
NYSE: DAL
Key Data Points
The stock looks cheap, but should you buy shares?
Based on its forward guidance, Delta Air's stock is quite cheap. It trades at a forward P/E below 6 while the S&P 500 trades at an earnings ratio above 20. Delta's business is not going away anytime soon, either. Its brand is now almost 100 years old.
But investors should know the company does have a lot of debt on its balance sheet. This brings its enterprise value up to around $37 billion compared to its market cap of $24 billion. On top of this, airlines are capital-intensive and generally struggle to convert earnings to free cash flow. I think a better earnings ratio for Delta is enterprise value-to-free cash flow (EV/FCF) instead of the traditional P/E. Using its forward free-cash-flow guidance of $3 billion to $4 billion, Delta's EV/FCF between 9.25 and 12.3.
This is still cheap, but not as cheap as a forward P/E of 6. Despite this, shares still look undervalued at these prices. If you are bullish on the airline industry, Delta could be a solid buy after its Q4 earnings drop.
