With the sale of S&P 500 (SNPINDEX:^GSPC) component BMC Software to Bain Capital LLC, a new spot is opening up in the index -- and Delta Air Lines (NYSE:DAL) has been given the slot. Let's see why Delta was added, and what this development could mean for the airline's shares.
The S&P 500 is designed to incorporate companies from all across the market, from paper producers to Internet retailers. When the S&P decided to add another airline, Delta Air Lines became the index's only legacy carrier.
The S&P 500 looks for companies that both fulfill its goal of broad based diversification, and are financially sound enough not to collapse on a regular basis.
Delta has made major strides toward improving its financial picture since it emerged from bankruptcy in 2005, reducing its net debt from $17 billion in 2009 down to a forecasted $10 billion by the end of 2013. Not only has this move reduced Delta's interest expense, but it has also helped to boost the airline's credit rating, making Delta less risky in the eyes of investors.
The only other airline in the S&P 500 is Southwest Airlines (NYSE:LUV), which operates in a different style than legacy carriers like Delta. Southwest operates an all-Boeing 737 fleet to save on maintenance costs, and flies primarily domestic routes. Through good management and some smart bets on oil prices that helped the airline through tough economic times, Southwest is widely considered among the most stable members of the industry.
When the S&P 500 decided to add another airline, a legacy carrier would help to broaden its airline mix -- and Delta represents the most financially sound airline among the legacy carriers. Delta is also by far the largest airline by market capitalization among legacy carriers. Since the S&P 500 tends to favor larger companies, this position would have given Delta an advantage in the index's eyes.
Effects on shares
Shares of U.S.-based airlines have suffered lately as a reaction to the uncertainty of the US Airways-AMR merger. On the backs of this and rising oil prices, Delta shares sank back below the $20 level on Sept. 6. However, the news that Delta would join the S&P 500 drove Delta shares up slightly in after-hours trading.
Clearly, the market sees Delta's S&P spot as positive news. It shows that the S&P's rewarding Delta's efforts, and since numerous mutual funds track the S&P and its components, it could create additional buying pressure on Delta stock going forward.
Changing investors minds
Legacy airlines have a major image problem on Wall Street. After a history of bankruptcies and unstable profits, many investors are understandably hesitant to put their money in a legacy airline. But a series of consolidations, improving debt levels, and better capacity management have been boosting airline earnings and fueling an airline stock rally.
Delta's debt reductions and reinstatement of a dividend are helping to bolster its image as different from the historical legacy carrier. Barring any game changing events, look for Delta shares to benefit from its inclusion in the S&P 500 over the next few weeks, as S&P related funds update their holdings. Its new spot in the S&P likely lend the company any long-term advantages, but it does highlight how far the airline has come, and how much stronger it's gotten.
Alexander MacLennan owns shares of Air Canada, American Airlines, Delta Air Lines, and Gol Linhas. He is also long the following options: $22 January 2015 Delta calls, $25 January 2015 Delta calls, $30 January 2015 Delta calls, $17 January 2015 US Airways calls. This article is not an endorsement to buy or sell any security and does not constitute professional investment advice. Always do your own due diligence before buying or selling any security. The Motley Fool recommends Southwest Airlines. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.