Looking at the one-year stock chart, you'd have no choice but to conclude that Delta Air Lines (DAL 2.90%) is a better stock than legacy peer United Continental (UAL 2.97%) when it comes to delivering for shareholders.
No-brainer, right? Not really. Stock charts tell us plenty about price action and almost nothing about how management is pulling levers to produce returns for shareholders. Fortunately, there's a tool to find out. We call it a DuPont analysis.
Wait, like the chemical company?
Precisely. DuPont popularized the idea of measuring the components of return on equity, or ROE, in the 1920s. The five-step model, illustrated below, takes a deep dive into the income statement and balance sheet in order to better understand how management uses all the assets at its disposal to produce progressively higher ROE.
Credit: The Motley Fool.
Breaking down the break-down
Why study ROE? It's a key metric that takes the most common measure of profits -- net income -- and divides by average equity, otherwise known as the capital acquired from outside investors or earnings kept for reinvesting in the business. At a high level, positive ROE indicates a profitable return on the funds invested.
What we want to know is where these earnings are coming from. Is management genuinely outperforming, or using artificial sweetener to boost results? The DuPont analysis answers this question by breaking ROE into five components: pre-interest, pre-tax profit margin, asset turnover, interest burden, tax efficiency, and the equity multiplier. Let's compare how Delta and United perform in each of these areas, starting with the two that tell us the most about management's choices.
How effective is management?
The first two steps of the DuPont analysis look at how well the executive team deploys corporate assets for financial gain.
Pre-tax, pre-interest profit margin -- generally known as EBIT, or earnings before interest and taxes, margin -- is core profits divided by sales. The higher the number, the better the business is at squeezing profit from its principal product (in this case, a seat on a passenger aircraft). Asset turnover measures how efficiently management turns assets into sales. Here's how Delta and United stack up:
| Company | Pre-Interest, Pre-TaxProfit Margin | Asset Turnover |
|
Delta |
10.87% |
79.83% |
|
United Continental |
3.59% |
101.65% |
Sources: S&P Capital IQ, Author's calculations.
As you can see, Delta does better pricing its flights, but United gets more out of its fleet.
Taxes and leverage
Strategic use of debt and equity is key to success in the airline industry. The next three indicators say a lot about how well management toes the line between prudence and excess.
Interest burden gives us a view of the cost of producing profits where a lower number means a higher cost. For example, say a company produces $100 million in EBIT and pays zero interest. The "burden" is 100% [(100-0)/100]. Conversely, if another company in the same industry pays $90 million in interest in order to produce $100 million in EBIT, the burden rises to 10% -- a troubling sign.
Tax efficiency works similarly, and it's important because taxes can be a huge cost to businesses that depend on tangible assets such as aircraft and ground equipment. A high ratio indicates a smaller tax burden.
Finally, the equity multiplier measures the impact of debt. The higher the number, the more debt management is using to acquire assets for producing profits. Such leverage can amplify results in good times, or cripple operations in bad times. As an industry, airlines have seen plenty of both. Here's how Delta and United stack up:
| Company | Interest Burden | Tax Efficiency | Equity Multiplier |
|
Delta |
81.69% |
312.94% |
889.04% |
|
United Continental |
48.95% |
102.95% |
1663.34% |
Sources: S&P Capital IQ, Author's calculations.
Delta is more efficient in every area, enjoying a lower interest and tax burden while using less debt to acquire assets and build equity. To be fair, though, Delta's results are influenced by $7.4 billion in income tax credits. United, by contrast, got just $20 million in credits.
Delta: flying higher
So what's the final tally? Unsurprisingly, Delta comes out on top when it comes to producing meaningful returns on equity:
| Company | Profit Margin | Asset Turnover | Interest Burden | Tax Efficiency | Equity Multiplier | ROE |
|
Delta |
10.87% |
79.83% |
81.69% |
312.94% |
889.04% |
197.15% |
|
United Continental |
3.59% |
101.65% |
48.95% |
102.95% |
1663.34% |
30.63% |
Sources: S&P Capital IQ, author's calculations.
No doubt the disparity is heavily influenced by Delta's tax status while United deserves credit for getting the most out of its assets while shouldering a heavy debt burden. Make sure to account for these variances before investing.
Now it's your turn to weigh in. Which airline do you prefer in the Delta vs. United showdown? How does the DuPont analysis inform your thinking? Leave a comment below to let us know what you think.
