Backed by solid cash flow from operations, Delta Air Lines (NYSE:DAL) recently hiked its dividend by 50% and authorized an additional $2 billion for share buybacks through 2016.  Beginning in the September 2014 quarter, the carrier’s shareholders will receive dividends at the rate of 9 cents per share, up from 6 cents per share. With roughly 850 million outstanding shares that means quarterly dividend payment of approximately $75 million or annual dividend payment of around $300 million from the company.
Delta restarted its dividends about a year back, highlighting its strong balance sheet and solid cash flow from operations. At the time, it also promised to buyback shares worth $500 million through mid 2016. But buoyed by stronger than anticipated financial performance over the last year, the carrier accelerated its buyback and is now on track to complete the promised $500 million buyback by around the middle of this year, two years ahead of schedule.  So, the carrier has now promised to buyback shares worth an additional $2 billion through 2016.
We figure this ability of Delta to return greater cash to its shareholders has been enabled by its many revenue and cost initiatives. At the same time, the stable outlook for air travel demand and jet fuel prices has also likely played a key role in enabling Delta to promise higher shareholder returns. We currently have a stock price estimate of $38.17 for Delta, approximately in line with its current market price.
Delta’s Solid Profits In Recent Years Has Enabled It To Raise Shareholder Returns
Over the last few years, Delta has taken multiple steps to boost its margins and profits. The carrier launched structural cost controlling measures like fleet renewal and distribution channel changes to control growth in its non-fuel costs. At the same time, its investments in larger airplanes created revenue opportunities in many markets. As a result, Delta’s pre-tax margin improved from negative territory in 2009 to 8% in the twelve-month period ended March 31, 2014.  This growth in margins in turn drove up the carrier’s profits, which enabled it to lower its debt as well as restart dividend and share buybacks.
In May last year, when the carrier restarted its dividend payouts and share buybacks, it also set long term goals for many important parameters. The carrier targeted 10-12% operating margin, 10-15% annual earnings growth, 15% return on invested capital (ROIC), roughly $5 billion annual operating cash flow and $7 billion adjusted net debt by 2015.  But last year, on gains from steady jet fuel prices and solid demand environment, the carrier booked better than anticipated profits of around $2.7 billion (excluding special items) and generated an admirable $4.5 billion in cash flow from operations.  This better than expected financial performance coupled with the steady outlook for jet fuel prices and air travel demand, propelled Delta to raise its expectations for these key parameters. Thus, earlier this month, the carrier announced that it now targets long term operating margin of 11-14%, annual earnings growth of 10-15% after 2014, ROIC of 15-18%, annual operating cash flow of around $6 billion and adjusted net debt of $5 billion by 2016.  Thus, the carrier has hiked its operating margin and debt reduction targets.
Stable Demand & Fuel Prices Will Be Crucial For Delta To Achieve Its Raised Targets
In our view, for Delta to meet its new debt reduction target and higher shareholder returns, its future operating cash flows will have to remain high. Currently, the carrier plans to spend roughly $2-3 billion per year on capital investments such as new airplanes and lounge facilities, among others. It also promises to return on average around $1.1 billion per year to shareholders (through dividends and share buybacks) through 2016.  It will also need to make significant pension contributions in the coming years. So, any significant fall in operating cash flows will weigh on Delta’s ability to return the promised cash to shareholders. However, we figure the chances of this happening are low, as the demand for air travel is likely to remain solid and jet fuel prices, which constitute the bulk of Delta’s total costs, are also likely to remain steady on gains from rising crude oil production in the U.S.. Thus, Delta’s operating cash flows will likely continue to remain solid for the foreseeable future. These strong operating cash flows in turn will likely enable the carrier to sustain its higher dividends and fulfill its raised share buyback plans. In addition, recent consolidation in the airline industry especially the merger of American and US Airways will likely also help Delta post higher profits in the coming years, enabling it to sustain its strong operating cash flows.
Separately, the increased targets for key parameters reflect that Delta is confident of maintaining its solid results in the coming years.
United & American’s Higher Debt Loads Are Preventing Them From Returning Capital To Shareholders
In comparison, Delta’s larger rivals – American (NASDAQ:AAL) and United (NYSE:UAL) – lag behind in terms of operating cash flows and shareholder returns. Neither of them have been able to restart returning capital to shareholders through dividends or buybacks. This is so because unlike Delta they haven’t been able to grow their profits and lower their debt loads. While American has only recently emerged from bankruptcy, United has operated for over three years after emerging from bankruptcy in 2010. Yet last year, United posted unsatisfactory profits of around $570 million and operating cash flows of around $1.4 billion.  With high capital investments in new airplanes and airport facilities as well as payments for debt reduction, it is unlikely that United will be able to restart dividends or buybacks anytime soon. Like Delta, it will first have to lower its debt load and capital lease obligations, which at the end of last year stood at over $12.4 billion.  In comparison, American’s debt and capital lease obligations stood at nearly $16.8 billion at the end of last year.  Thus, these carriers will first have to pay down their debts through increased profits. Higher profits and lower incremental debt contributions will in turn leave them with greater cash to distribute among shareholders.Notes:
- Delta announces plan to return an additional $2.75 billion to investors through 2016, May 6 2014, www.delta.com [↩] [↩] [↩] [↩] [↩] [↩]
- Delta’s 2013 10-K, February 2014, www.delta.com [↩]
- United’s 2013 10-K, February 2014, www.unitedcontinentalholdings.com [↩] [↩]
- American’s 2013 10-K, February 2014, www.aa.com [↩]