How Can A Change In Oil Prices Impact Delta’s Valuation?

The fortune of the US airline companies took a drastic upturn when crude oil prices, which form the core of their operating costs, crashed in mid-2014. Since then, these companies have earned huge profits, which they have utilized to revamp their operating fleet as well as balance sheet to return higher value to their shareholders. That said, the rebound in crude oil prices over the last few quarters has led to a decline in the profitability of these airline companies. In this note, we show how a change in crude oil prices can impact the profitability as well as valuation of Delta Air Lines (NYSE: DAL) using our interactive dashboard.

Increase In Oil Prices Could Lead To Higher Fuel Costs

Since fuel costs are the major operating costs of an airline, a marginal change in crude oil prices can significantly impact its operating expenses, and, in turn, its profits. However, airlines are aware of the volatility in crude oil prices. Consequently, they hedge a large portion of their annual fuel consumption at lower oil prices in order to improve their margins.

Based on our analysis and company guidance, we believe that a $1 per barrel rise in crude oil price could result in a 1% increase in Delta’s fuel cost. For instance, if the oil prices jump $5 per barrel higher than our base case estimate of $65 per barrel, it will cause the airline’s fuel expense to shoot up by 5% (blue bars). This will cause the airline’s net income margin to drop from our estimate of 10% to 9%, resulting in lower earnings per share.

Now, if we assume a P/E multiple of 6.8x for Delta Airlines, we arrive at a price estimate of $42 per share, which is roughly 7% lower than our base case price estimate of $45 per share. Thus, we figure that Delta’s valuation is sensitive to the movement in oil prices.

Do not agree with our forecast? Create your own price forecast for Delta by changing the base inputs (blue dots) on our interactive platform.