Delta Air Lines (NYSE: DAL) looks well-positioned to fly higher thanks to favorable industry tailwinds, attractive valuation, and positive earnings momentum. It is a Zacks Rank #1 (Strong Buy) stock.
Delta Air Lines offers service to 327 destinations in 59 countries on six continents. It operates a mainline fleet of more than 700 aircraft and serves nearly 165 million customers each year. The company is headquartered in Atlanta.
Nice Tailwind from Oil
Like most airlines, the cost of jet fuel is Delta’s largest expense, representing approximately 33% of total operating expenses for the first nine months of 2014. As a result, the collapse in oil prices has provided a nice tailwind for the company. Delta does hedge a portion of its fuel costs through hedges, but it still benefits overall from lower oil prices.
In its latest 10-Q, Delta estimated that a 20% drop in fuel prices would reduce its net fuel costs by +$1.68 billion between October 1, 2014 and December 31, 2015 as the decrease to unhedged fuel costs more than outsets the losses on its hedges.
It’s also important to note that falling oil prices have benefited shareholders much more than passengers as ticket prices have stayed high thanks to strong demand.
Positive Q4 Guidance
On January 5, Delta provided guidance for its upcoming fourth quarter, which it is scheduled to report on January 20. The company stated that it expects an adjusted operating margin of 12-13%, which is a whopping 400 basis point improvement over the same quarter last year. It also expects around a 1% increase in passenger unit revenue and around a 3.5% increase in system capacity.
The company is also projecting an average adjusted fuel price of $2.59-$2.64 per gallon compared to $3.05 per gallon in the same quarter last year.
The Zacks Consensus Estimate for 2014 is currently $3.32, up from $3.23 ninety days ago. The 2015 consensus is now $4.63, up from $3.94 over the same period.
You can see the nice upward slope in estimates in the company’s “Price & Consensus” chart:
Shares of Delta Air Lines trade at just 10x 12-month forward earnings, which is a discount to the industry median of 12x. And its enterprise value to cash flow ratio is only 4x, which is well-below the industry median of 10x.
Delta generated approximately $2.8 billion in free cash flow through the first nine months of 2014, the majority of which it used to pay down long-term debt and improve its balance sheet.
The Bottom Line
With reasonable valuation, positive earnings momentum, and continued favorable industry tailwinds from falling oil prices and strong demand, Delta Air Lines still looks well positioned to fly higher.
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