This site requires a more recent version of Adobe Flash Player to function properly.
Go here to get Flash.
Trefis's graphical modelling tools require Flash, but here's a preview of some of the content you'll see once
Flash is enabled:
Investment Overview for Delta Air Lines (NYSE:DAL)
WHAT HAS CHANGED?
- Declining Crude Oil Prices
Since July 2014 global crude oil prices have plummeted from over $110 per barrel to almost $45 per barrel in April 2016, representing a drop of close to 60%. This steep decline has been driven by the mismatch in the demand supply of crude oil worldwide, caused by the following factors:
- Weakness in global demand for oil, primarily due to slower growth in the Chinese economy
- Excess oil production because of the rise in the tight oil production in the US
- Organization of Petroleum Exporting Countries (OPEC) maintaining high production rates to defend their market share
Airline companies, including Delta Air Lines, have been a key beneficiary from this global trend, as jet fuel costs constitute more than one-third of an airline's total operating expenses. A sharp drop in these costs results in huge cost savings for the airline which bolster its earnings. While the outlook for crude oil prices is uncertain, the following developments are likely to delay the recovery of oil prices at least to 2017:
- Iranian nuclear agreement, which has waived all international sanctions on Iran's oil production, is expected to result in an additional supply of oil in 2016.
- Weakness in the Latin American market is expected to drive down the demand for oil in the near future.
With a challenging outlook for the oil price environment in 2016, we expect Delta's profits to continue to surge in the coming quarters.
- Strategic Investments To Enter Latin America And China
Over the years, Delta has been heavily investing in building its Latin American network and restructuring its Pacific operations through equity investments and joint ventures with various carriers. Apart from its existing joint ventures with Air France/KLM, Virgin Atlantic, and Virgin Australia, the airline entered into a long-term exclusive partnership with China Eastern to build a hub in Shanghai. In addition, the network carrier has increased its stake in GOL Aereos, the largest Brazilian domestic carrier, to almost 10% to expand its operations in the Latin American markets. We expect these strategic investments to expand and diversify Delta's network into high-revenue and high-growth markets inorganically, and improve its long-term profitability.
- Returning Value To Shareholders
The increased cash flows from lower fuel costs over the last few quarters have enabled Delta to return higher value to its stakeholders in the form of dividends and share buybacks. The airline reinstated its dividends in 2013 and has been increasing the quarterly dividends by almost 50% annually. It currently pays a quarterly dividend of $0.135 per share, which is expected to be increased in May 2016. Apart from this, the legacy carrier also has an authorized share repurchase plan of $5 billion to be completed by 2017.
- Pricing Pressure Due To Rising Competition
Delta has been aggressively adding capacity to establish an international hub at Seattle, the home town for Alaska Air. Consequently, there is an unsaid battle ongoing between the two airlines which is creating a pressure on the airline's passenger yields. Further, Delta is also facing a tough time in Dallas as Southwest Airlines has been slashing air fares to push Delta out of its home base. In addition, the Gulf carriers are also posing a threat to Delta's revenue. All this has resulted in a sharp decline in Delta's passenger yields (unit revenue) over the last year.
Since other smaller airlines such as Alaska and Southwest have announced strong capacity expansion plans for 2016, Delta's unit revenues are likely to remain depressed during the year. The company expects its unit revenue for the second quarter of 2016 to decline by 2.5%-4.5%.
- Stronger Dollar Driving Down Revenue
While the strengthening of the U.S. dollar has made international travel cheaper for U.S. passengers, it has severely hit the revenues from international travel for most of the large carriers. As Delta has a significant presence in the international markets, its top line has seen a downward trend since the first half of 2015. As a result, the airline reduced its international capacity by 3.0%-3.5% in the last quarter of 2015. For 2016, the company will continue to restrict its international capacity growth between flat and a 2% decline. Consequently, we expect the airline's international revenue to remain weak as long as these currency fluctuations hold.
Below are key drivers of Delta Air Lines value that present opportunities for upside or downside to the current Trefis price estimate.
Delta - US
Fuel Expense % Revenue for Delta's US flights: Fuel expense is the largest operating expense incurred by an airline. For Delta, it has averaged around 34% (as a percentage of its revenue) over the last 7-8 years. It stood at 37% of its US revenue in 2014. However, due to plummeting crude oil prices since mid-2014, fuel expenses have declined substantially for the airline. Fuel expenses as a percent of revenue fell to close to 20% in 2015 due to the depressed oil prices.
Since the outlook for oil prices is weak, we expect the fuel costs to decline in the near term, before recovering to their historic levels by the end of our forecast period. If, however, crude oil prices fall further, and fuel expenses drop to 28% instead of the current forecast of 31% by the end of the Trefis forecast period, then there could be a potential upside of around 7% to the Trefis price estimate for Delta's stock.
- US Passenger Yield: Delta’s US Passenger Yield increased from $0.119 in 2009 to $0.172 in 2014. However, due to increased competition in the domestic market, the airline experienced pricing pressure which led to a sharp fall in its passenger yield in 2015. Delta's passenger yield declined to $0.170 during the year. However, we expect the competition to ease out causing the airline's passenger yield to grow steadily to $0.178 by the end of the Trefis forecast period. If, however, the carrier's passenger yield rises less than anticipated to grow to only $0.159, then there could be a potential downside of more than 8% to the Trefis price estimate of Delta's stock.
Delta Air Lines is one of the largest passenger airlines in the world operating an extensive domestic and international network which spans the Americas, Europe, Asia-Pacific, Africa, the Middle East, the Caribbean, and Australia. Delta and its subsidiaries operate over 4,000 flights every day. The carrier is headquartered in Atlanta.
Delta's route network is centered around the hub system it operates at airports in Amsterdam, Atlanta, Cincinnati, Detroit, Memphis, Minneapolis-St. Paul, New York-JFK, Paris-Charles de Gaulle, Salt Lake City, and Tokyo-Narita. Each of these hub operations includes flights that gather and distribute traffic from markets in the geographic region surrounding the hub, to domestic and international cities, and to other hubs. Delta's network is supported by a fleet of aircraft that is varied in terms of size and capabilities, giving it the flexibility to meet corporate demands for travel.
It also has alliances with other domestic and foreign airlines to aid its network. These alliances include code sharing, reciprocal frequent flier program benefits, joint promotions, and common use of airport gates among others. Delta is also a part of SkyTeam which is one of the three major global airline alliances.
Extensive service network
Delta has one of the largest service networks among other US airlines. A large service network enables the carrier to attract corporate travelers to its loyalty program which supports higher yields as many corporate travelers opt for first class travel.
International equity investments
Delta has made equity investments in Virgin Australia, Virgin Atlantic, Aeromexico, GOL, and China Eastern. These investments increase the carrier's presence in important international air travel markets, boosting its passenger traffic and revenues.
Oil prices significantly impact bottom line
Fuel expenses constitute the single largest cost head for airlines, making them vulnerable to hikes in crude oil prices. For Delta, fuel costs constitute around a third of its total operating expense. To reduce vulnerability to fuel price volatility, Delta engages in fuel price hedging.
Demand for flights is related to global economic growth
Demand for flights is highly correlated to the global economic growth. Thus, a decline in economic growth, or recession, reduces demand for flights, impacting passenger traffic for airlines. On the other hand, steady growth in the global and U.S. economy, grows demand for air travel, allowing airlines to raise their air fares, occupancy rates, and profits.
Focus on ancillary revenue
Many airlines, including Delta, are figuring out ways to grow their top lines through ancillary heads such as baggage fees, access to on-board WiFi/food/drinks, etc. Accordingly, airlines are investing to enhance their product offerings that include in-flight WiFi and other entertainment options, improved lounge facilities, and extra legroom seats.
According to an Amadeus/IdeaWorks study, North American airlines collectively produce one of the largest stream of ancillary revenues compared to other regions. A majority of the increase is attributable to stronger merchandising efforts by the carriers, as well as the addition of more à la carte services for sale.
Growing preference for low-cost carrier model
During the past decade, low cost carriers such as Southwest and JetBlue have gained significant market share in the U.S. Looking ahead, we figure these low cost carriers will likely continue to grow their market share, as their lower fares attract passenger traffic.
Consolidation in the industry has helped raise profits of all airlines
The U.S. airline industry has seen many mergers and acquisitions in the last decade, including the five big combinations of US Airways and America West, Delta and Northwest, United and Continental, Southwest and AirTran, and American and US Airways.
A more consolidated industry has worked to improve profits of all airlines. Fewer players in the market has made it easier for the remaining airlines to add capacity with restraint. Prior to this consolidation in the airline industry, individual airlines were adding capacity at higher rates in an attempt to grow their market shares. This rapid capacity addition resulted in an oversupply of seats, reducing margin and profits of all carriers.
Going forward, we believe as long as airlines add capacity with discipline, the industry should remain profitable.
How Does Trefis Modelling Work?
How do we get the historical numbers for this chart?
Trefis has a team of in-house Analysts who gather historical data from company filings and other verifiable sources. When historicals are available, we explain how we got them at the bottom of the Trefis analysis section below.
Who came up with the Trefis forecast for future years?
The Trefis team of in-house Analysts considers a variety of factors when projecting any forecast. The rationale for our projections is explained in the Trefis analysis section below.
How does my dragging the trendline on the chart impact the stock price?
- We use forecasts for business drivers to calculate forecasted Revenues and Profits for each division of the company.
- We then use forecasted Profits in a Discounted Cash Flow (DCF) model to obtain the Price Estimate for the company.
See more on: DCF Methodology
View All Help Topics