Delta Air Lines (NYSE:DAL) is in survival mode. DAL stock is down 62% from its 52-week peak, and off 59% from the beginning of 2020. But there seems to be some light at the end of the tunnel.
The situation is very dark for Delta, as with many other airlines. On April 22 Delta reported a March quarter adjusted pre-tax loss of $400 million. Moreover, the airline expects revenue will be down 90% in the June quarter, compared to a year ago.
This means the company is going to lose money for a good while. Delta said it was burning $100 million a day by the end of March. Management expects this to ameliorate to just $50 million a day by the end of June.
Keep in mind that for most airlines, a load factor of 75% on each flight is the break-even level. Delta reported that its March passenger load factor was 73.1%. But that mainly reflects normal loads in the earlier part of the quarter. Reaching break-even load factors is not going to happen for a good while.
About That Light at the End of the Tunnel
Delta reported it had $5.967 billion in cash at the end of March. The problem is that burning $75 million a day (the average between $100 million a day burn at the end of March and $50 million at the end of June) will cost $6.75 billion. In other words, Delta Air Lines is going to run out of cash.
So the company is going to have to raise more money. Reuters reported on April 25 that the U.S. Treasury had just sent $9.5 billion in additional payroll support program money to U.S. air carriers. In total, the four largest U.S. airlines will receive $19.25 billion. Delta is expected to receive $5.4 billion in total government aid, according to CNBC, including loans and grants.
OK. Great. But you can see that $5.4 billion will still only last 108 days at $50 million in daily cash burn. That is a little longer than one quarter, to say Sept. 30. In addition, it is possible that may already have been in the March quarter balance sheet.
So where is the light? For one, after Sept. 30, 2020, Delta can take steps to drop employees that the government says it cannot furlough or fire right now. Delta has 90,000 employees. It will have to get the cash burn rate to zero or less very soon after the end of that month.
One way would be to cut out a large portion of its employee base. For example, In Q1 Delta spent $2.77 billion in salaries and related costs. That equates to $30.45 million per day, or 60.9% of the estimated $50 million daily burn rate by the end of June.
Delta will have to ability to cut its costs dramatically after September.
Expected Economy Uptick Would Help
Another element of light is that the economy should begin to pick up by the end of the third quarter, with load factors likely have increased as various states exit quarantine restrictions.
In addition, if oil prices stay low through the next several quarters, that will help lower the daily burn rate as well.
But, of course, there is no guarantee that these factors will last. In addition, it is possible that until a vaccine is found, there may be additional flareups in cases of novel coronavirus. This could dampen a rebound in demand for travel, especially business travel. Airlines make up to 75% of their profits from business travel.
Stock Buybacks on Hold
People are upset that Delta and other airlines have spent so much on stock buybacks. But now the companies are fighting for their survival. Could this affect the companies from doing buybacks in the future?
Business Insider recently posted an interesting video article about the money wasted on buybacks, including at Delta. The report noted that Delta spent $11.4 billion on repurchases over the past seven years, including more than $2 billion in 2019 alone. Business Insider said that Delta spent $11.2 billion in 2019 in salaries and related costs. The point they make is that if cash had been left to accumulate, the company would not necessarily be in survival mode right now.
I think there is some truth to this. From here on, I suspect that companies in highly cyclical or disruption-prone industries could end up being more conservative on their share repurchase policies. After all, this is what steel and auto manufacturing companies have done for a long time.
This means that the potential upside for DAL stock, even after the company returns to profitability, may be stunted. You might now see the stock return to its former heights for a good long time.
What Should DAL Stock Investors Do?
One thing that prevents me from buying DAL stock right now is that the stock is trading for its book value per share. For example, shareholders’ equity at the end of March was $14.3 billion. By comparison, the market value of Delta stock is now $14.29 billion, or roughly the same value as book value.
There were 637.836 million shares of DAL stock outstanding at the end of March 2020, according to its latest SEC 10-Q filing. This means that its book value per share was $22.43 per share. At a price of $22.41, DAL is trading for 0.999 times book value per share.
I simply don’t think this reflects the inherent amount of risk that the company is facing going forward. The company could not even project when it will get profitable or where its break-even load factor would be in the next several quarters.
If you are a value investor, I would wait for DAL stock to be trading for half to two-thirds of its most recent book value per share. At that point, you can gauge whether the light at the end of the tunnel is more than just a speck. More importantly, you can assess the probabilities on the upside vs. the downside risks.
As of this writing, Mark Hake, CFA does not hold a position in any of the aforementioned securities. Mark Hake runs the Total Yield Value Guide which you can review here.
