Shares of Delta (NYSE:DAL) have plunged over the past few days as the airline operator updated investors with a bearish expense outlook for the remainder of the year. Specifically, thanks to various headwinds such as rising wage pressures and elevated maintenance costs, Delta is guiding for non-fuel expenses to rise more than expected for the balance of the year. That means lower margins and lower profits, which spooked investors.
Since announcing the increased cost outlook, DAL stock has shed nearly 10%. The stock now trades at just 7.5-times forward earnings, with a three-month-low price tag. Plus, the relative strength index has plunged into oversold territory. Time to buy the dip?
Almost. But not quite. Delta stock is technically oversold, and due for a bounce soon. But that bounce may be a head-fake. Fundamentally, I’d like to see this stock drop down to $50 before buying in.
As such, I’m on the sidelines for now. But, I’m watching the action in DAL stock closely. Any dips below $50 should be viewed as buying opportunities.
Delta Is Hampered by Rising Headwinds
The whole airline industry has been bogged down since early 2018 by multiple converging headwinds, including easing demand as a result of slowing global economic expansion and capacity under-utilization issues as a result of the 737 Max crisis over at Boeing (NYSE:BA). Broadly speaking, that’s why the U.S. Global Jets ETF (NYSEARCA:JETS) has shed 15% since late January 2018.
Delta stock has notably outperformed during that stretch. Since late January 2018, shares are down just 5%. What’s behind the 10 points of out-performance? A lack of 737 Max planes in Delta’s airline portfolio.
Long story short, Delta never bought any 737 Max planes, so while everyone else has been hurt by having to ground their 737 Max planes, Delta has felt no such negative impact. Instead, Delta has actually been a beneficiary of the 737 Max groundings, since lower capacity in competitive routes has pushed Delta’s prices, margins, and profits higher.
Importantly, this hasn’t been a small impact. According to Stifel analyst Joseph DeNardi, “Delta has a [sic] about 12.5 billion competitive [available seat miles] overlap with MAX routes.” And that equates to around 30% of Delta’s domestic capacity.
This 737-grounding tailwind will turn into a headwind in 2020. That is, as 737 Max planes get back in the air early next year, supply in those competitive routes will rise. Higher supply provides a headwind for pricing and margins. At the same time, the global economy continues to show signs of easing growth momentum, and that should force demand to ease some in 2020. Lower demand provides an additional headwind for pricing and margins.
Thus, heading into 2020, Delta’s tailwinds are turning into headwinds. The steady revenue growth and margin expansion that DAL stock has benefited from in 2019 may not persist in 2020, and that could be a problem for DAL stock.
Delta Stock Looks Appetizing Below $50
At current levels, DAL stock doesn’t look too appetizing. But, if shares drop below $50, that’s when the bull thesis will start to look compelling.
Here’s the logic: current Street estimates call for steady revenue growth over the next few years, flattish margins, and steady profit growth to $8 per share by fiscal 2021. Based on an airline sector average 8-times forward earnings multiple, that implies a fiscal 2020 price target for DAL stock of $64. Discounted back by 10% per year, that equates to a 2019 price target of $58. Thus, based on current Street estimates, Delta stock is undervalued here.
But those Street estimates may be too aggressive. Pricing headwinds from re-emerging 737 Max air supply could cause revenue growth to fall flat, as could demand headwinds from slowing global economic activity. At the same time, Delta has said that non-fuel expenses will keep rising, margins could be under pressure too.
Net net, it is likely that profits don’t climb towards $8 by 2021. Instead, my modeling suggests that 2021 earnings per share might come in around $7.50. Doing the same math as above, that equates to a 2019 price target for DAL stock of below $55.
Considering the risks on the horizon with respect to pricing, demand, and margin, I’d only buy DAL stock at a sizable discount to that 2019 price target. Below $50, DAL stock would trade at an approximate 10% discount to that price target. As such, below $50, DAL stock looks compelling.
Bottom Line on DAL Stock
Delta stock is staring at some major headwinds which could stall out this company’s growth trajectory in 2020. Because of this, the recent plunge in DAL stock is warranted. But, if weakness persists and drags the stock down to $50, the selloff will be overdone. At that point, I’d buy the dip. Until then, I’d stay on the sidelines.
As of this writing, Luke Lango did not hold a position in any of the aforementioned securities.
