Delta Air Lines
has been the leader of the pack as the U.S. airline
industry recovers from the Great Recession. In a period of less
than two years starting in mid-2012, Delta stock shot up from
less than $9 to an all-time high of $42.66 this past June.
Delta Air Lines One-Year Stock Chart, data by
However, Delta stock has fallen about 15% from its high,
hitting $36 in recent weeks. This may be a great opportunity for
investors to load up on shares of one of the most financially
solid airlines in the world.
A favorable valuation
At its recent price, Delta trades for a little more than 11
times expected 2014 EPS of $3.23. That makes it cheap in just
about anyone's book. Yet that figure actually understates just
how cheap Delta stock may be today.
First, Delta's earnings have been growing rapidly recently. In
2013, the company's adjusted pre-tax income was about $2.7
billion -- up from $1.6 billion the year before. For the first
half of 2014, Delta's adjusted pre-tax income totaled $1.9
billion, and the first half of the year tends to be seasonally
That puts Delta on pace to exceed $4 billion of pre-tax income
this year. Considering how rapidly Delta has been growing its
earnings recently, Delta stock should probably be trading at a
higher earnings multiple.
Delta has reported strong earnings growth in the last few
years. Photo: The Motley Fool
Second, Delta is currently reporting an effective tax rate of
38%-39% in its earnings releases. However, as of the end of 2013,
Delta had nearly $14 billion of deferred tax assets, primarily
due to losses incurred during the Great Recession and accelerated
depreciation credits. As a result, Delta will pay little or no
cash taxes for years.
Thus, while Delta is likely to report $1.5 billion-$2 billion
in annual tax expense for the next several years, this is just an
accounting maneuver. Free cash flow is a more meaningful measure
of the power of Delta's earnings.
In the 12 months ending on June 30, Delta generated $2.8
billion of free cash flow, or $3.31 per share. Thus, Delta stock
trades for approximately 11 times trailing free cash flow. Free
cash flow continues to rise, too: Delta's management recently
projected that the company will generate more than $3 billion of
free cash flow in 2014.
King of the hill
Among Delta's two main rivals,
, only American can come close to Delta in terms of
profitability. Delta earned adjusted pre-tax income of $1.9
billion on revenue of $19.5 billion in the first half of 2014,
representing a 9.7% pre-tax margin.
Meanwhile, American Airlines also earned a $1.9 billion
adjusted pre-tax profit. However, American had $21.4 billion in
revenue, so its pre-tax margin was a full percentage point lower
at 8.7%. United Continental trailed far behind the pack with
adjusted income of $430 million in the first half of 2014,
representing a paltry 2.3% profit margin.
American Airlines has posted strong earnings results
recently, but it trails Delta in free cash flow by a wide
margin. Source: American Airlines.
Delta also has a huge lead in terms of free cash flow over
American Airlines (let alone United). American has a
staggering level of capital commitments
and expects to spend more than $5 billion on capex on
average for the next several years. By contrast, Delta (which is
just slightly smaller) plans to spend just $2.3 billion on
capital expenditures this year.
Delta's superior free cash flow is an important advantage,
because it will allow the company to reduce its debt levels more
quickly while also returning a lot of capital to shareholders
over time, primarily through share repurchases.
A solid choice for long-term investors
Delta stock has quadrupled in the last two years, and
investors shouldn't expect to see a similar performance over the
next two years. However, while Delta stock isn't as egregiously
undervalued today as it was in mid-2012, it still seems quite
cheap in light of the company's recent earnings growth and
substantial free cash flow.
Long-term investors can afford to sit tight and enjoy the
benefits of Delta's strong cash flow. In the next few years,
Delta will be able to pay down the bulk of its debt, fund most of
its pension liabilities, and maintain a 1% dividend yield while
buying back some Delta stock.
As Delta fulfills most of its debt and pension funding goals
in the next few years, it will be able to devote ever more cash
to shareholder-friendly uses. Long-term Delta shareholders thus
have a lot to look forward to in the next five to 10 years.
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Is It Time to Buy Delta Air Lines, Inc.
originally appeared on Fool.com.
is short shares of United Continental Holdings. The Motley Fool
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