Delta Air Lines (NYSE:DAL) looks poised for gains once it reaches positive free cash flow territory. This would be on top of the already significant gains that DAL stock has made this year. For example, the stock is up 28.5% so far in 2021. And in the past year, it has risen 35%. I suspect that once the airline announces that it is free cash flow positive, DAL stock will soar again.
The reason for this is simple. It essentially means that the business is self-sustaining and not burning cash. That usually leads to higher debt levels or additional dilutive common stock issues. This is because the airline has already cut its costs to the bone.
To Cash Burn or Not To Burn
Delta’s management announced in their most recent quarterly earnings that its Q1 cash burn averaged $12 million per day. That works out to about $1.092 billion per quarter. The company said it had $16.7 billion in liquidity at the end of December. Therefore, it could easily last another year if travel does not pick up and cash burn stays level.
But cash burn will improve. Management said in the earnings statement that they expect cash burn to fall to $10 million to $15 million during Q1.
Moreover, during the conference call management forecast an “inflection point” during Q2 where cash flow breakeven will occur. This will be the result of higher vaccinations in the general public and the Covid-19 virus infection rate falls.
In other words, by the end of Q2 or early Q3, the company will be able to report positive free cash flow. Delta Air Lines is in the best financial shape compared to most other airlines and is likely to be one of the first to achieve positive cash flow.
Valuing Delta Air Lines Stock
As a result, the market is likely to reward DAL stock with a higher stock price. For example, assuming revenue hits $26.1 billion this year, up 52.6% from 2020 revenue of $17.095, free cash flow might be as low as just 2%. That would give it an FCF rate of $522 million.
This would easily lead analysts to forecast a more normal FCF margin of 7% next year. For example, during 2019, Delta had $47 billion in revenue and $3,489 billion in free cash flow. That works out to a 7.4% FCF margin level.
Therefore, using a 5% FCF yield rate, which is very conservative, Delta could be worth as much as $69.78 billion. That is 120% above today’s market value of $32 billion and implies a price of $109.73 per share. This is calculated by dividing $3,489 billion (in FCF projected for 2022 using a 7% FCF margin) by 5%.
In fact, to be even more conservative in our forecast, let’s assume that the 2022 FCF margin will be just 5% on $47 billion of revenue. That implies Delta will have free cash flow of $2.35 billion. Dividing this by 5% (i.e., a 5% FCF yield), produces a target price of $47 billion. That also works out to one times sales.
This would still be 48.3% above today’s $31.69 billion market value and implies a price target of $73.90 per share.
What To Do With DAL Stock
Therefore assuming Delta produces 5% FCF margins in 2022 (well below its 2019 7.4% rate), and assuming a 5% FCF yield, DAL stock is still worth 48% more at $73.90.
Moreover, even if it takes a year and a half for DAL stock to hit $73.90, the average annualized return would still be 30% annually. That is a great ROI for most investors.
Therefore, expect DAL stock to shoot significantly higher this year once the company declares it is free cash flow positive.
On the date of publication, Mark R. Hake did not hold a long or short position in any of the securities in this article.
Mark Hake writes about personal finance on mrhake.medium.com and runs the Total Yield Value Guide which you can review here.
