Talking Stocks: Delta Air Lines
Updated: May 9, 2020
Being optimistic on airline stocks could be seen as quite naive, given the despairing sentiment around the industry nowadays.
From the reduced flights, to zero revenues and a complete halt in cash flow, COVID-19 has vehemently disrupted the core operations of airlines: resulting in several of the big players losing over 50% in value over the past 2 months.
Nevertheless, tough times are relatively trivial when it comes to strong businesses, and this is why many in the investing community strongly – yet cautiously – believe that Delta Air Lines will rise again regardless of the environment.
Consider three of the main reasons why below:
1. The Aviation Industry is Essential
Much akin to the everyday-use of entertainment, the aviation industry is foundational to consumers and the globalized nature of our economy. This presents two key benefits to airline companies as investments:
a) Consistent performance: Although we may not see large levels of growth, the aviation industry’s role in upholding travel and trade will provide consistent profitability in the long-term: with declined performances only occurring due to extraordinary circumstances (such as COVID-19). Averaging out the airline market’s performance over time results in a 7% profitability each year, which depicts its long-term reliability regardless of the virus’ short-term impact.
b) General all-year demand: As previously mentioned, the role of aviation in travel and trade is irreplaceable (for now), and this is why we can be fairly certain that demand for flights will return to normal levels as soon as the contagion of the virus begins to slow. This is particularly the point in time where confidence in the airline industry will likely surge, as a return to normal consumption patterns will soothe investor concerns and therefore augment demand for aviation stocks.
Figure 1: Annual Demand for Airline Services
Source: (Statista, 2020)
The two merits above make aviation stocks extremely reliable yet lucrative opportunities, especially given the potential for growth once operations properly resume.
Key Point to Consider: While all aviation stocks appear quite attractive as of now, the notion of going “up-in-quality” (from last week’s article) is still imperative in order to avoid potential losses. This means targeting companies with fundamentally sound balance sheets and strong cash flows: both of which lead us smoothly into the second merit of Delta Air Lines as an investment.
2) Strong Financials
Relative to most of its competitors, Delta Air Lines holds a superior set of financials, the highlights of which include:
a) Cash Reserves to navigate losses: Delta are sitting on almost $3 Billion in cash, which will aid in settling short-term financial obligations and laying-off the lowest amount of workers possible. Moreover, the lower fuel costs – due to oil prices dropping over 60% – as well as the potential to receive government aid will benefit Delta when combatting the high fixed costs associated with airlines (insurance, hangar rentals, aircraft leases).
b) Undervalued Stock Price: Given the substantial drop in aviation stock prices, “quality” stocks such as Delta can almost be seen as bargains at the moment.
Figure 2: Illustration of Delta’s Undervalued Stock
Source: (Simply Wall Street, 2020)
The depiction above articulates that – based on fundamental analysis – Delta’s stock price will more than double before reaching its fair value. Even more so, the upward momentum that may occur once investor confidence returns could drive prices up even further. This emphasizes the potential to make over 100% returns when investing in “up-in-quality” stocks that have simultaneously suffered a large drop: both of which are characteristics of Delta Air Lines.
3. Airline Aid package
Given that air travel is almost considered a commodity, it’s practically assumed that – in the rare event of financial distress – the government will step in to ensure that the market leaders are not drastically affected.
This supposed “protection” of the industry is what uniquely separates the aviation market from most others: with only the banking sector possessing a similar notion of being governmentally shielded. Protective measures were recently announced on CNBC with a new $50 billion airline aid package introduced by Treasury Secretary Mnuchin: an action that will likely affect Delta stock by a) giving them an opportunity to offset some of their high costs and b) experiencing a sharp upward turn in momentum. For the latter, introducing this package will likely soothe investor fears regarding the industry's health, and therefore promote the idea that not only will Delta survive, but the worst of the volatile days are over when the government is ready to step in.
Given the fact that Delta shares rose 7.4% after the package details were released, this is certainly a stimulus that profit-seekers should keep a keen eye on.
So…Who is this investment for?
Based on the relative uncertainty surrounding when exactly we will see a substantial and consistent rise in airline stocks, this stock is currently suitable for 2 types of investors:
a) Risk-Taking: Investors with a higher stomach for volatility will identify with the core fundamentals of the aviation industry and prioritize the long-term reward of buying Delta shares cheaply over the short-term uncertainty.
b) Those looking to recoup losses: Investors who have suffered drops in their portfolio may be looking to bet on companies with not only an established history of strong fundamentals, but also those who have significantly dropped in value. This allows a much higher return if airline stock prices double to their usual level in the coming months.
While these two categories of profit-seekers may benefit the most from pursuing Delta, the core attributes of this company make it a suitable investment for almost everyone. Understandably, there is some uncertainty surrounding aviation stocks, but weighing up the asymmetrical risk between the potential for profit and the short-term volatility clearly gives us a conclusion for all profit-seekers.
For the near future, Delta Air Lines is a winner.