U.S. airline stocks hit some turbulence last week, starting on Wednesday after Germany’s Lufthansa (DLAKY) airline warned about smaller profits on weaker demand, sending its shares down more than 15% in Frankfurt. The fall-out continued, and stocks like Delta (DAL) fell around 8% in two days, recouping less than a point of that decline in Friday’s session. I see the dip as both a trading opportunity for a short-term bounce as well as a solid entry point for a longer-term holding.
At the moment, DAL is my favorite play and is now trading at an absurd 3.1 times trailing earnings. I had already begun to look at DAL, and last week’s selling presents us with too good an opportunity to miss. The retreat was not motivated by any fundamental shift in the way we should value the airline stocks, and momentum could return quickly.
In fact, May passenger loads were robust, and one U.S. airline that came out with its own numbers, JetBlue (JBLU), did not say anything that would justify the market’s chill. For DAL, the selling felt like profit-taking after a strong 42.7% run already in 2014.
Airlines like DAL have boosted revenue per available seat mile 6% to 7% over the last year, which by industry standards represents an outright travel boom. DAL is particularly interesting because, unlike rivals whose schedules have become jokes among frequent travelers, 85% of Delta’s flights actually take off and land on time. This indicates how efficient the company’s operating platform is compared to its “transitional” competitors; while other carriers are still absorbing recent mergers, DAL is a well-oiled machine.
From a value perspective, it is hard to find a more compelling bargain – in or out of the airline group. DAL’s price/earnings ratio of 3.1 compares to an industry average of 10 and an overall transportation sector P/E close to 20, so we have a stock that has exhibited strong momentum most of the year but is still cheap. Over the last five years, DAL has traded as high as 18 times trailing earnings, but we are now closer to the historical low of 2.2 times earnings, so this has the look of a once-in-a-generation chance.
Revenue growth has been steady, but the real story here is on the bottom line. Delta only recently returned to profitability, so we could see some follow-through in terms of margin expansion as management initiatives play out. As it is, the company’s 44% gross margin is one of the highest in the airline industry, which gives it a relatively thick shield against rising fuel prices. Operating margins are nearly triple what competitors have achieved.
DAL’s earnings are due on July 23, and the whisper numbers give me a sense that DAL is in line to take off again after this brief bit of turbulence. A bounce back to $42, where it traded just last Tuesday, would result in a quick 7.1% gain if you buy DAL shares right here at this level.
Hilary Kramer is the editor of three financial advisory services designed to help individual investors profit from her stock picking talents — Hilary Kramer’s GameChangers, Breakout Stocks Under $10 and High Octane Trader.