Many investors dismiss airline stocks out of hand and it’s easy to see why. Profit margins are typically thin, labor strife is endemic and a spike in fuel costs can sink even a money-making airline. But smart contrarians know that investing shibboleths are meant to be broken.
As the global economic recovery accelerates, consumers increasingly want to travel. That, combined with falling fuel prices, is giving a powerful lift to the airline sector. One of the world’s best-managed and most efficient air carriers, Delta Air Lines (DAL), is benefiting from growing air traffic and shrewd, long-term fuel-saving strategies.
On Tuesday, Delta’s stock rose more than 3% in morning trading to $42 a share after it reported strong October gains in revenue per seat flown.
Despite its lean overhead, growth prospects, and recent strong performance, the stock is trading at a low valuation. Now is the time for investors to buy a cheap seat for a long-distance growth ride.
A Lift in Air Travel Demand
The airline industry’s major trade group, the International Air Transport Association (IATA), this year revealed good news for airline sector investors. IATA’s latest report showed that passenger demand in 2013 jumped 5.2% compared to the previous year. IATA predicts similar growth for 2014.
As of this writing, the price of benchmark West Texas Intermediate crude has slipped to just $75 per barrel. But long-term, fuel costs are likely to remain high and volatile for airlines, posing an ever-present risk to profitability. However, in a bold and innovative move, Delta has mitigated that threat by actually purchasing a $150 million refinery near Philadelphia from ConocoPhillips (COP). Delta has invested another $100 million into the refinery, to increase its output of jet fuel. Delta also reached a deal with BP (BP) to provide a steady supply of crude oil to the refinery. Delta estimates that its refinery will cut its annual fuel costs by $300 million.
Delta also opened a new $1.2 billion terminal at JFK International Airport in New York City, as a hub for expanded service to emerging markets as well as London Those destinations are posting particularly strong passenger demand. These advantages aren’t shared by major competitors such as US Airways Group, which continue to struggle with costs.
Ready for Takeoff
In mid-October, Delta reported third-quarter revenue of $11.2 billion, an increase of 7% compared to the year-ago quarter. Adjusted for one-time costs, earnings per share (EPS) in the quarter came in at $1.20, beating the consensus estimate of $1.18. That said, third quarter EPS was below the previous year’s $1.41, because of higher operating expenses.
Despite recent gains in the stock and its stellar growth prospects, Delta sports a trailing 12-month price-to-earnings (P/E) ratio of only 3.63, compared to a trailing P/E of 10.8 for its industry of major airlines.
Delta is well-positioned to generate both higher revenue and earnings in the coming year on the strength of growing domestic and international demand. The company’s expansion plans and shrewd cost-containment measures also bode well for future quarters.
If you add to this mix its reasonable valuation, DAL is ready for takeoff.
As of this writing, John Persinos did not hold a position in any of the aforementioned securities.
