- By Mark Yu
"We want to give investors a consistent stream of cash and reward them for owning Delta," says Delta (NYSE:DAL) Chief Financial Officer Paul Jacobson.
Meanwhile, the $35.5 billion Delaware-incorporated and Georgia-based Delta Air Lines reported 1.2% year over year revenue growth to $19.94 billion in its first half of its operations.
In contrast, however, Delta added $1.12 billion in operating expenses or 7.1% higher than prior year period leading to a drop of (-)26.7% to $1.83 billion--9.2% margin vs. 12.7% in the year prior period.
Several components of operating expenses climbed more than 10 percentage points year over year such as depreciation and amortization, contracted services, aircraft maintenance materials and outside repairs. More interestingly, expenses for passenger services and aircraft rent climbed 19.8% and 28.8%, respectively, therefore pushing down Delta's profits in the first half.
"The June quarter ranks among the best in Delta's history as our people delivered top financial, operational, and customer satisfaction results - and it is an honor to recognize that performance with an additional $338 million toward our 2017 profit sharing.
"While 2017 is a transition period for Delta, we are encouraged by the improvement in unit revenues, leading to increasing conviction in our ability to expand margins as we move through the back half of the year."
Ed Bastian, Delta's chief executive officer
Valuations
Delta is undervalued compared to its peers. According to GuruFocus data, the company had trailing P/E ratio 9.7 times vs. industry median 12.7 times, P/B ratio 2.6 times vs. 1.8 times, and P/S ratio 0.92 times vs. 0.77 times.
Delta also had trailing dividend yield 1.67% with 16% payout ratio.
Average revenue and earnings-per-share estimates indicated forward multiples 0.88 times and 9 times.
Total returns
Delta has underperformed the broader S&P 500 index so far this year with 0.52% total returns vs. 10.25% (Morningstar).
Delta Air Lines
Delta Air Lines was founded in 1929 and is incorporated under the laws of the State of Delaware. The company provides scheduled air transportation for passengers and cargo throughout the United States and around the world.
Delta Air Lines' global route network gives us a presence in every major domestic and international market. Its route network is centered around a system of hub, international gateway and key airports that we operate in Amsterdam, Atlanta, Boston, Detroit, London-Heathrow, Los Angeles, Minneapolis-St. Paul, NewYork-LaGuardia, NewYork-JFK, Paris-Charles de Gaulle, Salt Lake City, Seattle and Tokyo-Narita. Each of these operations includes flights that gather and distribute traffic from markets in the geographic region surrounding the hub or gateway to domestic and international cities and to other hubs or gateways.
Delta Air Lines' network is supported by a fleet of aircraft that is varied in size and capabilities, giving the company flexibility to adjust aircraft to the network. Other important characteristics of its route network include its international joint ventures, alliances with other foreign airlines, membership in SkyTeam and agreements with multiple domestic regional carriers that operate as Delta Connection(R) (1).
Delta Air Lines currently operates three joint ventures with foreign carriers (2).
A transatlantic joint venture with Air France and KLM, both of which are subsidiaries of the same holding company, and Alitalia, which generally covers routes between North America and Europe.
A transatlantic joint venture with Virgin Atlantic Airways with respect to operations on non-stop routes between the United Kingdom and North America. In addition to the joint venture, Delta owns a non-controlling 49% equity stake in Virgin Atlantic Limited, the parent company of Virgin Atlantic Airways.
A transpacific joint venture with Virgin Australia Airlines and its affiliated carriers with respect to operations on transpacific routes between North America and Australia/NewZealand.
In 2016, Delta generated 70.9% of its revenue in the United States, 14.9%, in Atlantic, 7.4% in Pacific, and the remaining in Latin America.
Delta has two segments: airline and refinery.
Airline
Airline segment is managed as a single business unit that provides scheduled air transportation for passengers and cargo throughout the U.S. and around the world and other ancillary airline services.
In the first half, revenue in the airline business grew 1.2% year over year to $19.81 billion (90% of total unadjusted Delta revenue) and had margins of 15.3% compared to 20.4% the year prior.
The single digit revenue increase was brought by 2.4% rise in domestic airline business while experiencing (-)1.9% and (-)13% revenue drop in the Atlantic and Pacific. More particularly, the declines in the Pacific primarily resulted from yield and load factor declines driven by industry capacity growth in the region.
Airline metrics (some; 4)
1 PRASM
Passenger revenue per available seat mile (PRASM). The amount of passenger revenue earned per available seat mile during a reporting period. In the first half, PRASM increased 1.1% to 13.63?.
2 Passenger Mile Yield or Yield
The amount of passenger revenue earned per revenue passenger mile during a reporting period. In the period, passenger mile yield decreased 0.2% on flat capacity to ?16.03.
3 CASM
(Operating) Cost per Available Seat Mile (CASM). The amount of operating cost incurred per ASM during a reporting period. In the first half, CASM rose by 7.09% year over year to 13.58?.
4 Fuel gallons consumed
Self explanatory. Actual fuel consumed declined (-)0.56% to 1.97 billion on an average price per gallon $1.61 in the first half compared with $1.44--11.81% increase.
Refinery
In June 2012, Delta's wholly owned subsidiaries, Monroe Energy, LLC, and MIPC, LLC (collectively, "Monroe"), acquired the Trainer oil refinery and related assets located near Philadelphia, Pennsylvania, as part of the company's strategy to mitigate the cost of the refining margin reflected in the price of jet fuel.
The acquisition included pipelines and terminal assets that allow the refinery to supply jet fuel to Delta's airline operations throughout the Northeastern U.S., including our NewYork hubs at LaGuardia and JFK.
Delta's refinery segment operates for the benefit of the airline segment by providing jet fuel to the airline segment from its own production and through jet fuel obtained via exchange agreements with third parties.
The refinery's production consists of jet fuel as well as non-jet fuel products. Delta uses several counterparties to exchange the non-jet fuel products produced by the refinery for jet fuel consumed in its airline operations.
In the first half, revenue in the refinery segment grew 26.5% year over year to $2.27 billion and generated operating income of $50 million (2.2% margin) compared to (-)$38 million in losses the year prior.
Sales and profits
In the past three years, Delta recorded revenue growth average 1.62%, profit decline (-)25.4%, and profit margin average 7.93% (Morningstar).
Cash, debt and book value
As of June, Delta had $2.24 billion in cash and cash equivalents and $9 billion in debt with debt-equity ratio 0.67 times compared to 0.66 times in the same period last year. Overall equity rose by $1.67 billion year over year while debt increased by $1.21 billion.
Delta also had $9.62 billion in pension, postretirement and related benefits under its liabilities--$2.95 billion lower than last year period.
28% of Delta's $51.8 billion assets were identified as blue sky elements or goodwill and intangibles while book value increased by 14% year over year to $13.48 billion.
Cash flow
In the first half, Delta's cash flow from operations declined by (-)62.5% year over year to $1.59 billion most probably as a result of lower profits in the period. Capital expenditures were $1.79 billion leaving the air line with (-)$205 million in free cash outflow compared with $2.31 billion in the year prior period.
Despite the outflow, Delta handed out $1.1 billion in payouts, such as dividends and repurchases, and took in $1.36 billion in debt net repayments and other.
The cash flow summary
In the past three years, Delta allocated $8.59 billion in capital expenditures, reduced overall debt by $4.57 billion (net issuances and other financing activities), generated $11.49 billion in free cash flow and handed out $7 billion in dividends and repurchases on an average payout rate of 61%.
Conclusion
Despite the lower revenue recognized in both the Atlantic and Pacific areas, Delta logged positive business growth in the first half. The company also has been refining its Chinese and Korean partnerships and has reached an agreement to create a joint venture with Korean Air in June. Investors then should keep an eye on this as it develops in the ensuing quarters.
Meanwhile, Delta's refinery business demonstrated inconsistency in generating profits in recent years.
Further, certain airline metric such as fuel gallons consumed indicated that an airline can still have higher cost despite stable consumption (11.8% higher despite (-)0.56% gallons consumed).
Investors should keep in mind that these fuel costs can yet still grow higher, Delta actually had 18.8% of its total expenses associated with fuel costs in the first half vs. three-year average 25.6%. In fact, when oil price averaged at a nominal price of $85.6 in 2014; Delta had 35.4% of its expenses in fuel.
Delta also carried a good amount in its liabilities in relation to pension obligations, while having had a steady leveraged balance sheet at 0.67 times with a little more than a quarter of its assets identified as blue sky elements.
Despite its high related capital expenditures, Delta generated steady free cash flow and was focused on both rewarding its shareholders at a prudent payout ratio of 61% in recent years while having kept reduced its debt.
Delta is a buy in terms of average analyst recommendation with a target price of $66.25 a share vs. $49.79 at the time of writing. Meanwhile, average revenue estimates with three-year P/S multiple average with a 15% margin indicated a per share figure of $48.72.
As long as oil price stay low, Delta is a buy with $65 a share target price.
Notes
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Company filings
Delta Air Lines' international alliance relationships with foreign carriers are an important part of its business as they improve access to international markets and enable the company to market globally integrated air transportation services. In general, these arrangements include reciprocal code sharing and frequent flyer program participation and airport lounge access arrangements and with some carriers may also include joint sales and marketing coordination, co-location of airport facilities and other commercial cooperation arrangements. These alliances also may present opportunities in other areas, such as airport ground handling arrangements, aircraft maintenance in sourcing and joint procurement.
2. Company filings
These arrangements, for which Delta has received antitrust immunity from the U.S. Department of Transportation, provide for joint commercial cooperation with its partners within the geographic scope of those arrangements, including the sharing of revenues and/or profits and losses generated by the parties on the joint venture routes, as well as joint marketing and sales, coordinated pricing and revenue management, network planning and scheduling and other coordinated activities with respect to the parties' operations on joint venture routes.
Disclosure: I do not have shares in any of the mentioned.
This article first appeared on GuruFocus.
