Although we don't believe in timing the market or panicking over market movements, we do like to keep an eye on big changes -- just in case they're material to our investing thesis.
Shares of Delta Air Lines (NYSE:DAL) plummeted 6% on Monday, closing at $30.90. At the worst point of the day, the stock had been down more than 8%. The poor performance followed a few rough weeks for Delta shares, which now sit more than 25% below the all-time high set earlier this year.
There are two big issues motivating all this selling action in Delta stock:
- Fears about the impact of the Ebola virus on air travel.
- Fears about the global economy.
Neither of these problems poses a very big threat to Delta at the moment. Delta shareholders should try to maintain a long-term mind-set, rather than selling in a panic. In fact, this might be a great time to scoop up some more shares.
Ebola is not eradicated from the U.S.
Airline stocks (including Delta) fell en masse after the first case of Ebola was reported in the U.S. late last month. Those stocks seemed to be stabilizing last week -- though they still fell along with the broader market.
Now a second case of Ebola was confirmed this past weekend, as one of the nurses who treated the first Ebola patient has contracted the disease. There was also a possible case of Ebola reported in Massachusetts, although that now appears to have been a false alarm.
The continuing threat of a larger Ebola outbreak has many investors worried about a repeat of the 2003 SARS epidemic, which dampened worldwide air travel demand. While there's still some risk of a moderate downturn in air travel, Ebola cases have mainly been confined to Africa, which is not a significant market for any U.S. airline, including Delta.
Revenue holds up despite pockets of weakness
In addition to the threat of a wider Ebola outbreak, slower global economic growth has weighed on global airline stocks. In early September, Delta reduced the high end of its Q3 unit revenue guidance, calling for 2%-3% growth, rather than 2%-4% growth.
Delta attributed the slight reduction in unit revenue growth to its international markets. Airline industry capacity grew too quickly in the trans-Atlantic market this past summer, while the World Cup temporarily hurt demand for travel from Latin America to the United States. However, these issues are already being resolved.
In fact, Delta's unit revenue is holding up quite nicely, considering that cost pressures have eased. Earlier this month, Delta projected that it will post a record 15%-16% operating margin when it reports Q3 earnings later this week. That's far better than either of the other two legacy carriers.
Room for error
Oil prices have fallen about 15% since the beginning of September, which could translate to over $1 billion in annual fuel cost savings for Delta. That's a huge earnings tailwind, and it provides a lot of wiggle room for Delta to absorb pockets of demand weakness while still posting strong earnings growth.
Delta is on pace to generate more than $4 billion of pre-tax income and more than $3 billion of free cash flow this year. Moreover, it has made significant progress in rebuilding its balance sheet in the five years since the Great Recession. Nevertheless, Delta's market cap has dropped to just $26 billion, or less than 9 times free cash flow.
This is an absurdly low valuation. Long-term investors shouldn't panic about Delta's poor stock performance in the past few months. The company's fundamentals remain rock solid, especially when compared with other airlines. If anything, investors should take advantage of this opportunity to buy Delta stock at a very good price.
Adam Levine-Weinberg and The Motley Fool have no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools don't 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.
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