Despite low valuations on the stock market that would attract value investors, Delta Air Lines, Inc. (NYSE:DAL) is stuck in a downtrend in 2018. Delta stock trades at a P/E of 10 times and forward price-earnings multiples are even lower at around seven times.

Persistently rising oil prices would bring ominously lower profits, if not operating losses, for airliners. No one knows when energy prices will stop going up, so this uncertainty is limiting the upside in DAL stock.

At a  JPMorgan Aviation, Transportation and Industrials Conference on Mar. 14, Delta touted its strong financial results, focus on customers and an investment grade balance sheet. It recent March quarter benefited from cost controls and strong revenue.

Looking ahead, Delta forecasts earnings growth, helped by its efficient operations relative to the industry. High customer satisfaction will also support the airline’s results in the quarters ahead.

Delta Stock Grossly Undervalued

According to SimplyWall.St, Delta’s stock price trades below its future cash flow value by more than 40 percent. At a recent price of $53, Delta stock is far-off from the $112 future cash flow value.

Source: https://simplywall.st

Looking Ahead, Delta Air Lines forecasts earnings of between $0.65 – $0.75 a share in the March quarter. It is on track to earn between $6.35 – $6.70 a share in 2018. One caveat in its outlook is the view that fuel prices were more favorable from its initial guidance, thanks to RINS benefit at the refinery.

Yet the recent surge could spell trouble. Saudi Arabia is already signaling ambition for an $80 per barrel oil price. Without hedges in place, that would spell trouble for Delta, American Airlines Group Inc. (NASDAQ:AAL), and United Continental Holdings, Inc. (NYSE:UAL).

The latter major airlines trade at significant discounts on the stock market, with the forward P/E in the high single-digit range.

In its fourth quarter, management faced fuel prices rising 30 percent year-over-year but still performed well, thanks to strong demand and high yields for products like the Delta One suite and Delta Premium select. But it will still need to cover higher costs increases in the medium and long-term through recapture fuel. That is, through higher revenues.

Positive Customer Experience

Airliners do not have any moat but with Delta, its improved customer experience and brand strengthening will separate its product from its competitors. Delta budgeted over $12 billion for spending over the next ten years. It has the funds earmarked for airport facilities in Atlanta, LaGuardia, Loss Angeles, Seattle, and Salt Lake City.

As mentioned previously, differentiating products added positively to Delta’s revenue. In Q4, the company made $200 million more, thanks to the First Class upsell and Comfort+, which both grew 25 – 30 percent. Delta forecasts $350 million more coming from incremental branded fare contributions and $2.2 billion annually.

March Headwind

The upcoming quarter is Delta’s seasonally weak period, where it faces peak cost growth for the year. The company forecast costs (which exclude oil costs) going up 2 percent to 4 percent in the quarter. Finally, both maintenance expenses and depreciation will show up on the balance sheet for the first half of the year. The second half will contrast with sharply lower cost recognition.

Delta’s seasonally weak period, due to higher cost recognition, does not explain the stock’s short-term underperformance. Investors could be pricing in the higher oil prices ahead. In Q4, total fuel prices rose $349 million, which is due to the 10 percent rise in oil prices.

Valuation

On average, the 17 analysts on Wall Street have a $73 price target on the stock. 11 models created on Finbox.io (click on the link to access price targets) users believe DAL stock has a fair value of $80.77. That implies upside of around 54 percent.

Will the stock get there? Oil prices may continue rising, forcing management to take a more proactive approach to hedging oil. But prices may moderate later this year as OPEC raises output. That positive scenario is not getting priced in Delta stock.

Disclosure: Author does not own shares in any of the companies mentioned.