Delta Air Lines (NYSE:DAL) rejoins the list of 500 stocks that make up the S&P 500 with the start of trade on Wednesday, September 11. The airline replaces BMC Software that is being bought by Bain Capital, and it will join competitor Southwest Airlines (NYSE:LUV) in this index. Delta was dropped from the S&P 500 in 2005 before it filed for bankruptcy and its re-entry to the index is a result of its large scale internal reorganization focused on lowering costs, cutting debt and improving business fundamentals.
This move from S&P to include Delta in its 500 index was not completely unexpected as Delta steadily gained market cap over the past few years driven by benefits from its internal reorganization and higher demand for its flights, but the move came sooner than expected. Nonetheless, following the announcement to include Delta in the S&P 500 on Monday, September 9, the company’s stock rose by over 10% over the next two trading days. We figure this rise is largely a result of increased demand for Delta’s stock from index funds that benchmark their investments to the S&P 500.
Here we highlight the factors that aided Delta’s return to this index. We currently have a stock price estimate of $20.30 for Delta, around 10% below its current market price.
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Delta’s Amazing Recovery From Its 2005-2007 Bankruptcy
Delta filed for bankruptcy in 2005 citing an unsustainable cost structure. However, during its bankruptcy that lasted from 2005 to 2007, the carrier lowered its cost structures through multiple measures that included among other things renegotiated labor contracts. Thereafter, in 2008, Delta bulked up in size with the acquisition of Northwest to become the largest carrier in the world by passenger traffic. Though two years later it was overtaken by United (NYSE:UAL) through the acquisition of Continental, Delta remains the second largest airline in the world marginally behind United.
From 2010 onward with the global economic recovery, the carrier steadily posted rising annual profits that crossed $1 billion last year.  During this period, Delta also cut its operational costs through multiple initiatives that involved replacement of less efficient airplanes with more fuel-efficient ones, maintenance redesign, distribution platform changes and staffing efficiency. This allowed the carrier to consistently cut its non-fuel operating costs.
At the same time, Delta’s rising profits driven by cost reduction and higher demand for flights in a recovering economy allowed it to pay down its debt. The carrier lowered its adjusted net debt – which adjusts debt, capital lease and aircraft rent obligations for cash – from a high of $17 billion at the end of 2009 to a little under $12 billion at the end of 2012. By the end of the current year, Delta anticipates to further lower its adjusted net debt to $10 billion, and in the long term plans to cut it to around $7 billion.  This significant reduction in debt reduces not only interest payments for the carrier but also the risk to its balance sheet. A couple of months back, Delta announced that it will re-start quarterly dividend payments, which it paid out for the first time in around a decade on Tuesday, September 10, at an annual yield of around 1%. The carrier has also undertaken an active share repurchase program.
In all, driven by these initiatives, Delta’s stock price rose by nearly 160% from mid-2008 to value the company at over $19 billion at present. Coupled with strong cash flow from operations and low debt, entry to the S&P 500 which has only one other airline stock was on the cards.
Looking ahead, we believe the carrier is positioned for further growth with earnings expected to rise in 2013 from 2012. We figure Delta’s large service network which attracts and retains premium corporate customers through its frequent flier program and the carrier’s strategic equity investments in international carriers that include Aeromexico, Virgin Australia and Virgin Atlantic (pending approval) bring depth to its business as well as position it for growth. At the same time, a favorable demand environment particularly on Latin America and Asia-Pacific international routes will support Delta’s further growth.Notes: