Delta Air Lines: Going Strong And No 737 MAX Concerns – Seeking Alpha

Delta Air Lines: Going Strong And No 737 MAX Concerns - Seeking Alpha
5 Must-See Highlights From Delta Air Lines Q1 Earnings Call
Delta has delivered outsized returns for shareholders who invested over the last four to five years, and the trend continues.

Delta has no Boeing 737 MAX in its fleet. It may benefit significantly, in the short and long term, from groundings of and passenger apprehension toward the 737 MAX.

The only way an investor can realize a return from an investment in shares is through receipt of dividends and/or gains on sales. I repeat – the only way.

Delta expects steady growth in revenue from the AmEx partnership beyond 2019, as the number of co-branded credit card holders grows and those cardmembers increase their spending. And there will be another big step-up in revenue in 2023, presumably due to Delta getting an even better revenue split from American Express. As a result, management is highly confident that this high-margin revenue stream will more than double to $7 billion between 2018 and 2023.

If analyst consensus estimates for Delta are close, further share price gains are likely. Despite recent share price increases, strong returns are still likely buying at today's share price levels.

I authored an article Delta Air Lines (NYSE:DAL) “Phoenix Rising” back in January, after release of its FY 2018 results on Jan. 15. Delta released its Q1 2019 results on April 10, announcing,

Delta Air Lines cost performance was just as impressive as its revenue performance last quarter. Adjusted nonfuel unit costs ticked down slightly in Q1, while fuel efficiency improved 2.1% year over year. An aggressive program to upgrade Deltas fleet has been the primary driver of the companys improving cost trends. Recognizing the success of this effort, Delta recently decided to retire its remaining MD-90s earlier than expected.

But, even at the higher current share price level, Delta still offers the prospect of attractive returns of 10% to 13% per year. As usual, I provide the Analysts Corner proprietary 1View∞Scenarios dashboards further below, which allow modeling of a range of qualitative data inputs, including analysts consensus forecasts, historical P/E ratios, dividend growth rates, share repurchases, potential interest rate changes, etc., to arrive at indicative rates of return over the next three to four years. Whats not included in these projections is the potential favorable impact on Delta of the Boeing 737 MAX disaster.

As of the end of Q1, Delta had 37 MD-90s, with an average age of 22 years. It already has plans to replace its last 79 MD-88s by the end of 2020, but with more than 160 new narrowbody jets set to arrive between now and 2021, Delta should be able to retire its last MD-90s by sometime in mid-to-late 2021, if not earlier. The airline plans to offer more details in the coming months.

Its an ill wind that blows nobody good. Delta has no Boeing 737 MAX in its current fleet, and none on order. It may benefit significantly, in the short and long term, from groundings of and possible passenger apprehension towards the 737 MAX operated by its airline competitors.

Deltas choice of Airbus (EASDF) over Boeing (NYSE:BA) may have had as much to do with subjectivity as objectivity. By subjectivity, I mean the poor vendor/customer relationship Boeing created with Delta by Boeings attack on a Boeing competitor supplying to Delta. In 2017, Boeing succeeded in having the US Commerce Department impose a 300% charge (80% tariff plus 220% penalty) on Bombardiers (OTCQX:BDRBF) sale of up to 125 CS100 airplanes to Delta. At the time per this CNN report,

Bombardier and Delta contend that the model it purchased does not compete with anything Boeing produces. Delta said it was “confident” Bombardier will prevail in the end because no U.S. manufacturer makes an aircraft that competes with the CS100.

Demand for SkyMiles as a currency is stronger than ever. Mileage redemptions grew 12% in the March quarter, as we provided customers more opportunity to use their miles. … Increasingly, customers are using miles for products and services beyond just award tickets, as we expand miles as a form of payment.– Hauenstein

Fast forward to 2018, and Seattle Times reports under the heading, “In fight over Bombardier CSeries, Boeing loses friends as well as tariff case,”

A U.S. trade tribunal on Friday threw out Boeings case against the Bombardier CSeries jet and quashed the prospect of tariffs that would have closed the U.S. market to the Canadian aircraft.

However, Delta has been predicting a rebound in free cash flow to between $3 billion and $4 billion this year. Now, management is increasingly confident about hitting the high end of that target range, largely thanks to the $500 million in incremental revenue expected from the American Express partnership renewal.

By that time, Delta had already committed, in December 2017, to a $12.7 billion order for 100 Airbus A321neo, according to Seattle Times, which also reported,

Last week, we were pleased to announce a contract renewal with American Express, extending our agreement through 2029. … Deltas benefit is expected to grow to $7 billion by 2023, up from $3.4 billion last year, and just $1 billion at the start of this decade.– Delta Air Lines CEO Ed Bastian

The Airbus A321neo is a single-aisle, midrange plane that competes with Boeings 737 MAX. Delta said it will begin getting the 197-seat jets in early 2020 to replace smaller planes.

While the exact terms of the new agreement are confidential, Delta expects approximately $500 million of incremental revenue this year from the renewal. That likely indicates that American Express offered improved terms in order to maintain its valuable relationship with Delta.

I have not made any allowance in my dashboard projections for possible revenue and income benefits from the competitive advantage to Delta of not having any 737 MAX in its fleet of airplanes.

Last week, Delta Air Lines (NYSE:DAL) reported strong results for the first quarter of 2019. Revenue for the core airline segment rose 7.5% year over year. Adjusted earnings per share surged 28% to $0.96, cruising past analysts estimates and managements own guidance.

Deltas CEO played down the impact of 737 MAX in response to a question on the Q1 2019 earnings call,

…the MAX, it represents a really small part of our industrys market share at this point, and were not going to get into any specific details relative to the interline arrangements we have with some of our partners that maybe flying that product…. I would expect the numbers are not going to be material to Delta.

Following the earnings release, several top Delta Air Lines executives spent an hour discussing the companys strategy and recent performance with Wall Street analysts and the media. Here are five key highlights from their remarks.

Im not so sure about that. Firstly, there will be passengers who will avoid the 737 MAX even after the grounding is lifted. Secondly, there are passengers who will fly Delta instead of their usual airline and may be impressed by the experience, and change their loyalties. Both of these have the potential for long-term impact. And thirdly, both American Airlines (NASDAQ:AAL) and Southwest Airlines (NYSE:LUV) have announced they are extending cancellations until August because of the 737 MAX grounding (see here). The revenue impact may be small, but it could be the icing on the cake for increased capacity utilization and margins. And from here through August covers the busy summer holiday travel period.

Delta continued to show strong and increasing TTM non-GAAP earnings growth in Q1 2019. Through end of Q1 2019, Delta TTM non-GAAP earnings grew by 16% over the prior year, compared to 13.8% for Q4 2018 TTM. Comparable year-on-year TTM growth on an EPS basis was 22.8% for Q1 2019, and 18.6% for Q4 2018. The higher EPS TTM growth is due to share repurchases reducing share count. Analysts consensus forecasts are for year-on-year growth of ~19% in 2019, followed by mid to high single digit growth in 2020 and 2021.

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Deltas share price growth was negligible, from end of 2014 when it was $49.19, through to January 2019 when it was $50.27, at the time of publication of my previous article in January. Since then Deltas share price has grown by ~22%% to $58.05 on April 12. This recent share price increase has resulted in significant gains for short-, medium- and long-term investors in Delta. The question for investors is whether the projected earnings growth will be sufficient to continue to drive share price increases to provide a satisfactory return over the next few years. Because the only way an investor can realize a return from an investment in shares is through receipt of dividends and gains on sales of shares. I repeat — the only way.

The American Express partnership is just one of several growing revenue streams helping Delta rely less on the pricing of economy fares, which have been more-or-less commoditized.

Analysts Corner proprietary 1View∞Scenarios dashboards are used to assess what investors in Delta can reasonably expect to enjoy in the way of returns in the future, compared to those available over the last six years. Using analysts estimates available through SA Essential and Nasdaq (Zacks research) and company guidance, we find theres a likelihood of attractive returns in the future, even at the current higher share price levels.

Deltas aggressive fleet renewal plan has driven a substantial increase in capex recently. This caused free cash flow to recede quite a bit from the highs of a few years ago.

What I need to do now is undertake the process of determining whether a purchase of Delta shares at current prevailing prices is likely to provide an acceptable rate of return going forward. This process requires a look at the past, and quantification of a range of future expectations for Delta. table 1 below summarizes a sampling of results from investing in Delta over the last four to five years and exiting at the current share price.

[W]ith the efficiency gains weve made through our fleet transformation, we expect to accelerate the retirement of our MD-90 fleet.–Delta Air Lines CFO Paul Jacobson

For many stocks where I create a table similar to table 1 above, I find a wide range of returns, indicating a degree of volatility and risk. table 1 above shows the results for Delta were all positive for seven different investors, each investing $3,000 over the last four years, Average yearly rates of return range from 5.50% for investor A to 19.62% for investor D. These are not just hypothetical results, they are very real results for anyone who purchased shares on the various dates and held through to April 12, 2019. Table 1 shows a fairly stagnant share price from 2014 to early 2019. Most of the growth in share price has come over the last month or so. This has benefited all investors who have bought over the last four to five years up until when the share price began to climb steeply. This recent share price performance is not a guarantee of future performance. Whether now is an opportune time to enter an investment in Delta shares is examined in detail below.

My proprietary dashboards (see further below) allow an investor to project similar data to that contained in table 1 and conduct an infinite amount of scenario testing to see what returns might be available from an investment in Delta shares at todays price levels. I believe this quantitative approach is far superior to using Betas, forward P/E ratios, PEG ratios and other indicators to qualitatively review the prospects for an investment in shares. I feed analysts forecasts into my dashboards as part of the process of converting available qualitative data into projected rates of return. The nature of this forecast data leads to analyst quarterly consensus forecasts not adding up to analyst full-year consensus forecasts. Some moderation is required as shown in table 2 below.

Where the analyst weighted average consensus forecasts do not add to the equivalent full-year EPS, the quarterly EPS is adjusted per the “Adopt” column. Also, for 2022 theres only one analyst providing a forecast. This analyst is obviously very enthusiastic about Deltas prospects, without any other analysts forecasts to moderate the consensus result. I hope they are right in their 2022 estimate. But, for the sake of conservatism I have arbitrarily reduced their $9.80 EPS to $8.00 for my projections. The EPS amounts per the “Adopt” column in TABLE 2 above have been used in the Dashboard Base projections further below. In addition, increases to the quarterly dividend rate have been input, effective in the third quarter of each year. Rates of increase assumed are $0.045 in the third quarter for all years 2019 to 2022. TABLE 3 below summarizes various historical financial data for Delta for purposes of comparison when assessing the reasonableness of the dashboard projections.

We are now in a position to review the auto-generated projected financial summaries. The first of these is our table 4 Base projection dashboard which incorporates the projected data included in our input.

These dashboards are similar in form and content to table 3 and include rate of return projections. The table 4 Dashboard 1 is designed to allow us to create and modify a Base forecast by manipulating inputs and seeing the resulting effect on rate of return, share price, P/E ratio and other meaningful statistics. When we believe we have created a suitable Base scenario we can then move to the table 5 dashboard which allows us to interactively vary input, and simultaneously see the effect on rate of return and other KPIs compared to the Base forecast.

We can now go to our “Dashboard 2 Base And Alternative Projections” to conduct alternative scenario testing.

In Dashboard 2 above, I have input additional changes in assumptions for an alternative scenario. The changes include:

Of course, its possible to construct an infinite number of scenarios by varying assumptions and instantaneously seeing the impact on dividends, dividend yield, and total rate of return. To limit the amount of information on the dashboard, I have not included a “dividends reinvested” case. But I can assure all those DGI investors who follow Seeking Alpha that the working model, available at Analysts Corner, does provide results for the “dividends reinvested” case.

As Im fond of saying, the only way an investor can realize a return from an investment in shares is through receipt of dividends and/or gains on sales. I repeat – the only way. Delta has delivered in that regard, as can be seen from the historical results for investors per table 1 above. Tables 4 and 5 above suggest that Delta is likely to continue increasing dividends, and to continue to deliver solid returns into the future, even after the recent increase in the share price. Its possible to do further scenario testing using Dashboard 2 to see what buy price for Delta would meet your individual target return objectives. That does not mean the share price will come down to a lower price. But it will position you to be able to act quickly if the share price does come down. Its only by projecting the future possibilities we can get an idea of what current Delta share price level would represent a suitable entry point. Different investors will have different ROR expectations. Use of a dashboard like those pictured above enables any investor to see whether Delta represents a buying opportunity for them at the current share price, and if not, at what share price it might be of interest. If theres concern at the effect of higher interest rates than those projected above, the effect can be easily seen with one or two simple inputs to the Base/Alternative scenario dashboard.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Disclaimer: The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned or to solicit transactions or clients. Past performance of the companies discussed may not continue and the companies may not achieve the earnings growth as predicted. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contained within. I do not recommend that anyone act upon any investment information without first consulting an investment advisor and/or a tax advisor as to the suitability of such investments for their specific situation.