Delta Air Lines: Positives Outweigh The Risks (NYSE:DAL)

Much has gone in favor of Delta Air Lines (NYSE:DAL) in the recent past, driving its price up by ~20% year-to-date after a 22% increase in 2023. Continued improvements in travel demand, an easing in inflation impacting costs positively, the resulting profits, and a positive outlook all support the DAL stock.

However, there are risks ahead. There’s some uncertainty about the macroeconomy on one hand and interest rates staying higher for longer on the other. There’s also the risk of industrial action, which hasn’t just impacted other airlines recently but has been a challenge across sectors.

Here, I assess how the balance of these opposing forces plays out to determine what’s next for Delta.

Can travel demand be sustained?

The first point to consider is travel recovery. According to consulting firm Bain & Company, air travel demand will surpass 2019 levels only this year. This shows up in the company’s numbers. But the forecasts are more cautious.

Healthy revenue growth and outlook…

Delta’s revenues grew by 8% year-on-year (YoY) in the first quarter of the year (Q1 2024), far higher than the 5.8% growth seen in 2019, the last year before the pandemic’s impact was visible. It’s also higher than the compounded annual growth rate (CAGR) of 4.5% for the past decade.

Looking ahead too, for Q2 2024, the company expects non-GAAP revenue growth to end up in the range of 5%-7% (see table below). This compares well with 6% operating revenue growth in Q1 2024.

…but demand slowdown can impact financials

However, the rest of the year might not turn out as well. Analysts’ estimates on Seeking Alpha, for example, put the full-year growth at 3.5%, indicating a slowing down in the second half of the year.

This forecast is further reinforced by the U.S. Travel Association that international travel to the US will reach pre-pandemic levels only in 2025. It also expects business travel to decelerate and points to already slowing consumer spending owing to macroeconomic factors like higher interest rates. This is significant for Delta considering that more than 60% of its revenues come from the US market.

Can profits continue to rise on lower costs?

Next, the company’s profit position has also improved, which can bode well for both its market multiples and dividends, discussed in the next section.

Improved earnings…

Its adjusted operating margin came in at 5.1% (Q1 2023: 4.6%) as adjusted operating expenses grew by just 6% YoY compared to a 26% increase in Q1 2023. While so far in 2024, the figure is far lower than the 11.6% for full-year 2023, the company expects the number to land even higher in 2024 (see table above).

There’s also a likelihood of higher earnings per share this year, with a 4% increase at the midpoint of the guidance range (see table below) from the USD6.25 level seen in 2023.

…but elevated interest rates can affect the business

However, it’s worth pointing out that if EPS comes in at the lower end of the guidance range, it would be a 4% decline from 2023. I wouldn’t rule out this possibility going by the latest consumer price inflation number for March, which is at 3.5%, the highest in six months, indicating that interest rates can stay higher for longer.

This in turn can impact net income through interest expenses. The company’s debt rose by 1.6x between 2019 and 2023. And while the interest cover ratio is more than comfortable at 7.3x, it has reduced significantly from the pre-pandemic level in 2019 of 21x. This in turn impacts the net interest expense, which was higher by USD533 million in 2023 compared to 2019 or USD0.83 per share.

While the company expects the adjusted debt-to-EBITDAR to continue declining this year (see chart below), it remains to be seen how much interest costs can fall, and bump up the EPS, or not.

There are higher labor costs

Earnings are also at risk from higher labor costs. Salaries and related costs are the biggest segment of the company’s operating expenses, accounting for 29% of the total in Q1 2024. They were also fast-growing at 12% YoY compared to the 1% increase in total operating expenses.

The company has also increased employee pay for 80,000 workers recently, possibly to assuage workers at a time when unionization is on the rise.

Automotive companies like General Motors (GM), Ford (F), and Stellantis (STLA) also suffered setbacks from prolonged strikes. Amazon (AMZN) and Starbucks (SBUX) are other key examples. The point here is that union action is strong at present, and Delta may well be impacted by it going forward, even though just 20% of its workforce is unionized at present.

Attractive market multiples and potential dividend increase

Considering the risks, the company’s EPS may well come in at the lower end of the guidance range. Interestingly though, even then, the forward non-GAAP price-to-earnings (P/E) ratio comes in at 8.2x, which is lower than the stock’s five-year average of 9.4x. This in turn indicates a ~15% upside to the stock. And in the best-case scenario, the upside jumps to 34%.

Dividends can also grow from here, irrespective of where the guidance range EPS finally ends up. In Q1 2024, the company’s dividend payout ratio was at 22%, where the non-GAAP EPS estimate is the denominator. Even at the lower end of the guidance range, if the ratio were to stay constant, the dividend payout could be at USD1.32 per share this year. This results in a forward dividend yield of 2.7%, a jump from the trailing 12-month yield of 0.6%.

What next?

The key takeaway from the Delta stock discussion is that the upside for the airliner is firm, even though there are undeniable risks ahead. Even if revenues slow down and EPS comes in at the lower end of the range in 2024 due to slowing demand, elevated rates, and increased labor costs, its forward P/E and dividends still look promising. I’m going with a Buy rating on DAL.