Monday, April 14, 2014

A World Where Flights Aren't Canceled- 04/15/2014
Topic: Delta Airlines


  1. Sources: Morningstar, Seeking alpha Trefis, Company 10K, MD&A, Boeing Outlook

    Delta Air Lines is one of the largest passenger airlines in the world operating an extensive domestic and international network. Delta's route network in centered around a system of hubs and gateway airports, such as Amsterdam, Atlanta, NYC-LaGuardia,JFK, Seattle and Tokyo-Narita.
    (reference items 2013 rev 32.9 billion, operating income 3.4 billion, FCF 1.9 billion)
    % of revenue
    passengers, 70%
    regional affiliate 17%
    Airport services 10.3%
    Cargo 2%

    FCF 5.9% of rev
    Uses of FCF
    - CapEx, 135%. Doubled from 2011, reflects the expansion investments
    - Dividends, 5%, first in 5 years
    - Share repurchase, 13%, first in 5 years
    - Debt repayment, 75%, decreased 2 times from 2011. Current D/E is 35%, company aims to reduce it to 27%
    - Interest expenses, 36%. decreased

    Used BI preselected Comps for RV
    Delta forward P/E 10.3, higher than median 8.9, FCF/yield= 7.1%, compare with a -4% industrial median.
    Delta's profit margin is 27.9%, far higher than UAL and AAL's (1.6%, .4%).
    Delta has a PEG of .18, compare with UAL and AAL's near .9 ratio. DEEP undervalued.
    What is going well
    - Delta’s results last year beat analyst estimates, as the revenue increase 4% and 3 year average net income increased 161%
    - Delta's market share in U.S. is estimated to be around 15.8%, and 13.6% in the international markets. Annual traffic growth is growing according to the Boeing Outlook estimates. In the next 20 years, traffic volume in MA-AP is projected to grow at 7.3% per annum, most regions 5-6% and NA 2.3%. Airline industry has an extremely high entry requirement, high market shares granted Delta strong economic moat to maintain revenue growth.
    - Careful route selection by Delta led to better performance. According to MD&A, Delta will begin 9 non-stop flights between NY and London, one of the most popular route. In addition, Delta will expand its operation in Seattle mainly targets to connect flight from Asia. In short, Delta continues to strengthen its global network by expanding it strategically. Delta is positioned to enhance future profits for investors.
    - Delta is currently replacing its old aircrafts to energy efficient new models; restructuring the fleet will allow Delta to absorb fuel price fluctuations, smoothing volatility in profits.

    What could go wrong:
    - Fuel costs, much of the improvement of net income in 2013 can be attributed to fuel costs decrease, which decreased operating expenses by 3%. This reduced costs is contingent and it is not part of the company's strength. Future fuel price fluctuation can negatively impact Delta.
    - Domestic operations face competition from both traditional network and discount carriers.
    - International routes are subject to both domestic and foreign competitors. Domestic carriers have greater access to sell international transportation through global alliance and code sharing agreements. Similarly for foreign carriers. Alliances formed by those carriers, for example SkyTeam, the Star Alliance, and the oneworld alliance intensified the competition in international markets. Though Delta offers FFP to passengers, buyer's bargaining power is high and can switch at low cost. Competition will pressure Delta's occupancy rate and rev passenger mile.

    Delta delivered superior financial performance over the past several years. Its strategy help to position Delta for further enhancement. In addition, Delta's reduced leverage ratios and optimized operations solidifies my recommendation.

  2. Sources:2013 10K, Seeking alpha,Morningstar, Zacks

    Business Overview: Delta Airlines is the second largest U.S. airline and provides scheduled air transportation for passengers and cargo throughout the U.S., and around the world

    It has four business segments: (% of total revenue in FY 2013)
    -Mainline: 70%
    -Regional carriers:17%
    -Cargo: 3%
    -Other: 10%

    Core Businesses: Mainline
    -Domestic 57%; Atlantic 21%; Pacific 14%; Latin America 8%
    -Mainline segment revenue increased 5%
    -The domestic region leading YOY unit revenue improvement of 8% increase as a result of higher passenger mile yield

    Customers: direct flyer, clients from regional carrier, airports the company serve
    Competitors for the major business units: domestic and international airline companies

    Financial Overview:
    -FCF: 1.9 billion year-end 2013, increased 2.8 times compared to 2012
    •FCF as % of Rev: 5.1% in 2013, 1.4%in 2012, 4.5% in 2011, 5.7% in 2010
    •FCF as % of OCF: 43% in 2013, 21% in 2012, 56% in 2011, 53% in 2010
    •Use of FCF:
    oCapital expenditure: 2.6 billion, primarily for the purchase of aircraft and aircraft modifications
    oDebt Repayment: 1.5 billion, improving financial position
    oAcquisition: purchased a 49% equity investment in Virgin Atlantic for $360 million.
    oShare Repurchase: 250 million
    oDividend payment: 102 million
    -Profitability: ROE: 221%; Net margin 44%; both are around 4 times of industry avg in 2013
    -Financial Position: D/E 0.84. Decreased significantly in recent years. The lower level of debt in DAL's capital structure is reducing the fixed charge of interest to a low level, and the company is less likely to be hurt materially during the economic downturn.

    What is going right?
    -Benefits from fleet restructuring: restructuring the older and less efficient fleet will allow Delta to absorb cost increases coming from higher wages and fuel price fluctuation
    -Synergies from acquisition of the Virgin Atlantic: This joint venture results in 32 daily non-stop flights between North America and Britain from March 2014.
    -Robust growth in the emerging economies of Asia, Latin America, and Africa enable DAL to generate more international revenue: According to Boeing, air travel industry in South Asia and China will have a robust average annual growth rate of 6.6% and 6.4% for next two decades.
    -Tax Assets: At the end of 2013 Delta had $15.3 billion of US federal pre-tax net operating loss carry-forwards. As a result the company will not pay any cash federal income taxes during the next several years and leaves a lot of room for better liquidity.

    What can go wrong?
    •Increasing competition: The competition is expected to increase further given the merger of US Airways and American Airlines and forming American Airlines Group, the largest global carrier. The new entity will have more pricing power and control over a larger number of slots, thus affecting the market share of Delta
    •Revenue affected by Federal government regulations. The airlines industry is highly regulated. As the passengers are switching to low fares, the new rules on pricing might hurt the travel demand, leading to lower profits for and Delta Air Lines
    •Changes in the price and availability of aircraft fuel. Fuel expense is Delta’s single largest expense. The company's ability to pass along the increased costs of fuel to its customers is limited by the competitive nature of the airline industry. A small change in fuel price thus will have significant in revenue.
    •Increasing in non-fuel expenses, including fleet restructuring, network expansion and higher salaries and wages. Salaries, the second biggest cost, increased 6% in 2013 due to employees receiving a higher pay.
    •The airline industry is both capital and labor intensive. In 2014, the company expects capital expenditure to be around $2.3 billion, which may narrow FCF availability

    Overall speaking, Delta has a very promising future and recommend to buy or long-term hold

  3. Source: 10k, morning star, seeking alpha
    Passenger: 87%
    Mainline: 70%
    Regional carriers: 17%
    Cargo: 2%
    Other: 10%

    --Domestic: 66%
    Atlantic: 17%
    Pacific: 16%
    Latin america: 6%

    --Growth rate: 3-yr CAGR
    Rev: 2.5%, operating income: 21.3%,
    Net income: got 8B income tax benefit, NI increased from 1B in 2012 to 10B in 2013.
    (During the December 2013 quarter, after considering all relevant factors, we concluded that our deferred income tax assets are more likely than not to be realized. At December 31, 2013, we released almost all of our valuation allowance against our net deferred income tax assets. The release of the allowance primarily resulted in a net tax benefit of $8.0 billion that was recorded in income tax benefit (provision))

    US passenger revenue growth 8%, Latin america: 11%

    --Gross margin: 24% in 2013, 22% in 2012, 41% in 2011, 47% in 2010
    Operating profit margin: 9%, 6%, 5%, industry avg: 5%
    Net profit margin: 28%, 3%, 2%, industry: 8%

    Competitors gross margin/operating margin:
    AA: 59%/9%
    Jetblue: 29%/8%
    Southwest: 53%/7%

    ROE: 2.21 times, industry avg 58%
    ROA: 21.8%, industry avg: 6.7%

    5% in 2013, 1% in 2012, 4% in 2011
    43% in 2013, 21% in 2012, 56% in 2011

    Use of FCF:
    Dividend: 5% of FCF
    Share repurchase: 13% of FCF
    Debt repayment: 75%

    Aircraft fuel and related taxes: 33% of operating expense. In 2013, fuel expense decreased 787M. $3.07 per gallon in 2013, $3.26 per gallon in 2012.
    DAL manage their fuel cost through three primary methods: purchase agreements, fuel hedging and the operation of a refinery. They acquire a refinery company near Philadelphia in 2012.
    Salaries: 22%

    --What going right:
    Opening up 9 non-stop route from NY to London in partnership with Virgin, one of the most popular route.
    The company is restructuringits domestic fleet by reducing the 50-seat regional flying aircrafts and replacing them with newer and more efficient models. This can effectively reduce their fuel expense.
    Reduce adjusted debt by 35%, resulting in a lower financial risk and cost of capital

    --What could go wrong:
    According to the Boeing estimates annual traffic growth 2012 to 2032, the highest growth rate itinerary is middle east-asia pacific, 7.3%, followed by Latin america and within china 6.9%. With north america is lowest growth rate: 2.3%. Delta mainly operates domestically, only 6% from Latin america. Lower traffic growth can be a threat to their revenue.
    Jet fuel price is estimated to increased 5%
    The wage increased 6% in 2013.

  4. Second largest airline in the world by scheduled passengers carried
    2 segments: airline and refinery
    By Revenue
    - Mainline passenger 70%
    - Regional carriers 17%
    - Cargo 3%
    - Other 10%
    By Geography
    - Domestic 66%
    - Atlantic 17%
    - Pacific 11%
    - Latin America 6%

    Free Cash Flow
    - 5% of revenue
    - 43% of cash from operations
    - uses its free cash flow to pay dividends, repurchase shares, and pay long-term debt and capital lease obligations
    P/E of 2.6 is the lowest in the industry

    Minimize its cancellation rate
    - Aircraft maintenance materials and outside repairs expense has decreased by over 5% in 2013

    Risk Factors
    - High fuel price, crude oil futures is expected to rise in the short-term, and it is not clear how this would impact Delta’s operating results
    - Highly competitive industry, discount carriers have placed significant competitive pressure on Delta in the US

  5. Data sources: 10-K; MorningStar; Seekingalpha
    Delta Air Lines, Inc. provides scheduled air transportation for passengers and cargo throughout the United States and around the world.

    Revenue breakdown
    • Mainline 70%
    • Regional Carriers 17%
    • Cargo 2%
    • Other 10%

    Free cash flow
    • 2011-12 4% 56%
    • 2012-12 1% 21%
    • 2013-12 5% 43%
    • Usage of FCF
    • Debt repayment -75%
    • Repurchases of treasury stock -13%
    • Cash dividends paid -5%

    Financial performance
    • Gross Margin/Operating Margin 44.5% from around 40% /9% from around 5.9%; Improving since 2011
    • 3-Year Average Growth for rev is 5.96%
    • The adjusted net income increased 150% in 2013 /rising revenue &lower fuel costs.

    What is going right
    • The company is now restructuring the older and less efficient fleet
    • DAL has constantly reduced debt each year/ 35% decrease from the 2009 level.
    • DAL's stock price grew by more than 130% during 2013

    What could go wrong
    • Insufficient funds to support its future expansion
    • With regards to costs airlines profits are greatly impacted when fuel prices fluctuate
    • It will increase the total cost of operation