Can Delta Afford Its Plan To Return Capital?

Delta Airlines (NYSE:DAL) initiated a shareholder cash return plan in its capital deployment strategy announced Wednesday, May 8. The carrier will be paying out a quarterly dividend of 6 cents a share beginning September 10 for shareholders on record as of August 9. At the end of the first quarter, Delta had 855 million shares outstanding, and will be paying out dividends worth approximately $50 million every quarter or $200 million every year at the current payout rate. In addition, the carrier announced a share buyback program worth $500 million that ends in June 2016. Together, through these two channels, Delta plans to return over $1 billion to its shareholders over the next three years. ^[1]

These developments send out a positive message to the investor community that Delta has sufficiently de-leveraged and therefore de-risked its balance sheet and that it sees stable earnings in the foreseeable future. We currently have a stock price estimate of $16.30 for Delta, approximately 10% below its current market price.

See our complete analysis of Delta here

Strong Earnings Growth Enabled Delta To Restart Dividend Payouts

Delta will be restarting its dividend program after nearly a decade. This is the result of strong earnings growth over the past three years which has enabled it to pay off a large portion of its debt. Delta’s earnings improved steadily from a loss of $1.50 per share in 2009 to a profit of $1.19 per share in 2012. ^{[2] [3]} This enabled it to reduce its adjusted net debt from $17 billion in 2009 to under $12 billion in 2012. ^[1] This adjusted net debt represents total debt, capital lease obligations and aircraft rent for the previous twelve months, net of cash holdings. Delta targets to further reduce its adjusted net debt to $10 billion by the end of 2013. ^[1]

Stable Operating Cash Flow Will Be Critical In Fulfilling The Promised Cash Return To Shareholders

Looking ahead, Delta anticipates continuing to grow its earnings on revenue opportunities arising from investments in Virgin Atlantic and New York (at LaGuardia and JFK airports) and on cost savings from investments in the Trainer refinery and other structural cost initiatives. This earnings growth will help the carrier in improving cash flow from operations.

Currently, Delta expects operating cash flow of around $4-$5 billion a year over the next five years. It plans to reinvest half of this – $2-$2.5 billion a year in its fleet, airport lounges and other products and technology, and use the other half for returning cash to shareholders, reducing its debt further and making contributions to pension plans. Delta aims to pay down its adjusted net debt to $7 billion over the next few years. This decline is also expected to halve its interest payments to $500 million from around $1 billion in 2012, contributing to earnings growth. The carrier also plans to make incremental pension contributions of around $1 billion over the next five years to lower its long-term pension liabilities. This will be in addition to the $650-$700 million in mandatory annual pension contributions required of Delta. ^[1]

Thus, as evident, in order to maintain annual capital investments of $2-$2.5 billion, reduce debt by $5 billion, make pension contributions of the stated amount and return cash to shareholders, Delta will have to maintain stable operating cash flows. However, operating cash flows of airlines are highly vulnerable to increases in crude oil prices or fare discounts from competitors. On the bright side, Delta will likely benefit from the recent industry consolidation, particularly the United-Continental integration and the ongoing American-US Airways merger, which will reduce the industry flying capacity and thereby competition and thus aid its profit growth.

To the investor community, the cash return program is a positive step, which indicates that Delta has come a long way from its bankruptcy and losses in the last decade. Apart from Delta, Southwest (NYSE:LUV) is the only other U.S. airline which has both dividend payout and share buyback programs. Southwest pays a quarterly dividend of 1 cent a share to its shareholders. ^[4] Alaska Air Group (NYSE:ALK) is another airline that has a share buyback program but not a dividend payout program currently.

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1. Delta’s capital deployment plan, Form 8-K, May 8 2013, www.delta.com [↩] [↩] [↩] [↩]
2. Delta’s 2010 10-K, February 16 2011, www.delta.com [↩]
3. Delta’s 2012 10-K, February 13 2013, www.delta.com [↩]
4. Southwest declares 146th consecutive quarterly dividend, January 31 2013, www.swamedia.com [↩]