Delta Air Lines: Undervaluation and Fleet Restructuring Provides Huge Growth Potential

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Oct 02, 2014

Delta Air Lines (DAL, Financial) was founded in 1924 and the company provides air transportation to more than 160 million travelers worldwide. Delta Air Lines first started as an aerial crop dusting company and since then with subsequent expansion of first its services in countries like Peru, Florida and California. Later the company entered the passenger services and expanded internationally to become one of the biggest airline companies.

Delta Air Lines' route network comprises of various gateway airports in Amsterdam, Cincinnati, Atlanta, New York, Paris etc. In addition to this the company also provides aircraft maintenance, repair, overhaul services and aviation solutions for third packages to name a few. Currently the company operates a mainline feet of approximately 700 aircraft.

This article will discuss reasons why Delta Air Lines is different from peers and how its current valuation makes it an attractive value buy.

Delta Air Lines' stock prices have increased by more than 250% in the past two years yet the company offers attractive valuation and high growth potential. Recent plunge in its prices makes it a good buy opportunity. In this article I will also discuss why Delta Air Lines is bound to grow and what makes it different from peers which make it a value investment.

Well-managed network

The company has its presence globally; Delta Air Lines has been managing its network to improve the profitability. In the Pacific region the company has been involved in the building of a Seattle gateway; the company has expanded service to existing destinations and added new services to new brand-new destinations.

Delta is also continuously working on the improvement of services by providing lobby renovation, Delta Sky Club, Sky Priority, Wi Fi on all domestic flights with expanded ticket counters, thus making the travel more pleasurable. In addition to this, the company has been building strong partnerships in order to build a strong network in the region.

Apart from the Pacific region, the company is expanding its network in the Atlantic and Latin America areas as well. Delta’s partnership with JV is expected to further increase the company’s capacity by 1%-3%, thus improving the company’s revenue. Also post Word Cup the demand for transport has regained and is expected to contribute to the company’s growth.

Domestic fleet restructuring

Delta Airines has been involved in the up-gauging of its domestic fleet, this is particularly to boost the margins. According to the Delta’s fleet restructuring plans, the company aims to replace its ~375 small regional jets with small mainline (100 seater Boeing’s 717) and larger regional jets (76 seater CRJs 900).

It will help the company to reduce per unit cost. Moreover, these larger planes are more fuel efficient and the airlines can now carry more traffic with fewer planes. This will also cut down on the company’s labour and maintenance cost. Thus, an improved cost efficient fleet has year to date produced 2% higher domestic capacity with 4% fewer departures. I thus believe that the combination of a restructured fleet with old aircrafts will produce higher returns on the invested capital.

Valuations

Delta’s current valuation suggests that the company is still cheap. The company is currently trading at a forward PE of 9, which makes it very cheap based on its solid financials and a rapid increase in its earnings per share.

Even if we compare the company’s valuations based on the EV/EBITDA with peers, the company is relatively undervalued. Delta is currently trading at an EV/EBITDA of 5.9 as compared to Copa Holdings’ (CPA, Financial) and American Airlines (AAL, Financial) 6.7. A better picture based on the valuation can be depicted on the company’s estimated 2015 EV/EBITDA as Delta is valued at 2015 EV/EBITDA of 4.8 compared to Copa’s 6.7 and Sector’s 9.0.

Conclusion

I believe that the company’s continuous effort in improving margins and increasing free cash flow will help it to achieve its target of $5 billion of adjusted net debt by 2016. Moreover, with the share repurchase authorization of $2 billion by the end of fiscal 2016, the company plans to return $1 billion by 2014 both in the form of dividend and share repurchase.

With the expansion of its operations in new regions and rebuilding its existing services with the restructuring of fleet, I strongly believe Delta has huge growth potential. I would recommend the stock as a long term investment and the current dip in its stock prices could be considered as a good entry point.