If you're a large blue chip company, then you know how hard it
is to generate robust growth. Yet that's precisely the case with
I profiled earlier this month
as my top pick for the Dow in 2013. Boeing's production ramp of new
planes should help keep the top line growing at a brisk clip in
In a bit of irony, it is another airline play that's shaping up
to be one of the best stocks in the S&P 500 right now. It's a
company that may not be poised for solid revenue growth in coming
years as Boeing is, but it's delivering a set ofbottom line results
so impressive, it's only a matter of time before investors finally
wake up to this stock's ultra-deep value.
I'm talking about
Delta Airlines (NYSE:
, which continues to post the best metrics in the airline industry.
And these metrics are poised to get even better.
I first profiled Delta's impressive flight path
in the summer of 2011
, concluding that "Delta is an extremely well-run company with a
very cheap stock."
After digesting just-released third-quarter results, it's time
to revisit how the company is faring and understand why this stock
-- which has risen 27% since I profiled it last summer -- has at
least 50% upside from here.
Getting its house in order
Delta's biggest task during the past few years has been to ensure
that a debt-ladenbalance sheet went on a diet. Quarter after
quarter, Delta has generated solidfree cash flow . The carrier has
paid off more than $5 billion in debt since the end of 2009,
bringingnet debt below $12 billion. And almost all of the remaining
debt won't be due for many years to come. The carrier's access to
more than $5 billion in liquidity (between cash and untapped credit
lines) means that a flirt with bankruptcy in a sharp economic
downturn is off the table.
But deleveraging a balance sheet can only help a stock up to a
point. Instead, it's theincome statement metrics that investors
will focus upon as they look for upside.
And this is where Delta's outlook is getting brighter.
In the third-quarter, Delta generated an industry-leading
10.2%operating margin . This has fueled a solid return on invested
capital, which is now around 12% during the past 12 months. The
remarkable aspect is that these figures have come at a time when
the globaleconomy sharply slowed and jet fuel prices sharply
The results should only get better in the quarters ahead for one
simple reason: Jet fuel prices have begun dropping, and
according to this article
from TheWall Street Journal, they could drop far lower.
Even before any projected drop, Delta is setting the stage for
solid fourth-quarter upside, thanks to current jet fuel price
trends. As part of management's formal fourth-quarter guidance,
Delta is assuming jet fuel prices of $3.15 to $3.20 a gallon
(compared with $3.14 a gallon in the third-quarter). Yet jet fuel
prices have recently fallen below $3 a gallon on thespot market .
Assuming that analysis from The Wall Street Journal plays out, then
jet fuel prices could move toward $2.75 a gallon by the end of the
quarter. This could set the stage forearnings upside.
Looking beyond fuel prices in the near-term, Delta is about to
embark on another round of streamlining that will shed another $1
billion in expenses by the end of 2013. Even though Merrill Lynch's
analysts assume Delta's revenue will grow just 1% in 2013 to $36.9
billion, they say cost cuts should fuel a 50% jump in earnings to
about $2.85 per share (and they see earnings rising to $3.40 per
share in 2014).
From another perspective, Delta is on track to boost free cash
flow 25% this year to about $2 billion. Thanks to a combination of
operational streamlining and a slowdown in capital spending, free
cash flow is also expected to rise to $2.5 billion in 2013 and $3
billion by 2014. This is quite impressive for a company that is
valued at just $8.5 billion.
To put this into context, we're talking about a $10 stock. Why
does this stock sport such a low forwardmultiple ? Because
investors, freshly scarred by American Airlines parent AMR's
bankruptcy filing around a year ago, still don't trust this
industry to survive the tough times. Yet as Delta keeps proving its
mettle in a very tough global economy, these concerns will
Risks to Consider:
If the United States slips intorecession in 2013,
thenshares of Delta are likely to be stuck in neutral -- at best.
So focus on this stock for its long-term potential.
Action to Take -->
While the economy is in a funk, the airline industry won't see a
big move up in earningsmultiples . But in Delta's case, it won't
take much. Even if the price-to-earnings (P/E ) ratio moves up to
just six times Merrill Lynch's 2013 forecast, then shares are
likely to move past $17, or more than 70% above the current price
($2.85 X 6 = $17.10).
Myopic investors are only taking note of Delta's progress
quarter-by-quarter, though you can benefit by focusing on this
high-quality company's long-term path of steadily rising profits
and a steadily stronger balance sheet. If you've got a longer time
horizon, then Delta is on a path to earn nearly $4 a share by 2015.
Slap a forward multiple of six on this figure, and you can see why
this stock could move up into the low $20s during the next few
-- David Sterman
David Sterman does not personally hold positions in any
securities mentioned in this article. StreetAuthority LLC does not
hold positions in any securities mentioned in this article.