Is Delta Air Lines Undervalued?



Invested hedge funds increased exposure to DAL

In the previous part of our series, we saw that hedge funds with significant exposure to Delta Air Lines (DAL) tended to increase their stakes in the company in 2Q15. This part of our series will focus on valuation metrics and the possible motivation behind hedge funds increasing their position in DAL.

Airlines like Delta Air Lines (DAL), JetBlue Airways (JBLU), Alaska Air (ALK), Southwest Airlines (LUV), and United Continental Holdings (UAL) are cyclical stocks as demand for air travel is heavily linked to the state of domestic and global economies. Additionally, airline companies’ profitability tends to get influenced to a large degree by fuel costs, as fuel costs comprise airline companies’ major cost component. Airline companies’ revenues and earnings tend to fluctuate depending on these two variables.

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DAL is the largest airline company in the United States in terms of market capitalization ($37.4 billion), ahead of American Airlines (AAL) and Southwest Airlines (LUV). The low fuel price environment, coupled with capacity discipline, has allowed Delta Air Lines to grow its revenues and profitability over the last three-year period.

DAL has outperformed the market in recent years, gaining 73.52% on a compounded annual growth rate basis for the last three years, compared to the SPDR S&P 500 ETF (SPY), which has gained 13.22%.

As we can see in the chart above, DAL trades at a PE (price-to-earnings) multiple of 11.9x. This is slightly lower than the peer average, 12.4x, and the S&P 500 PE multiple, 20.5x.

Delta Air Lines has traded at a discount to its peers over the last five-year period. With a debt-to-equity ratio of 0.8x, DAL’s leverage is somewhat elevated in comparison to its peers. ALK’s debt-to-equity ratio is 0.3x and LUV’s is 0.34x.

However, given DAL’s strong free cash flow generation, fleet size, and international presence, its current valuation still makes it an attractive pick in the airlines industry.

Assessing the timing of hedge funds with significant stakes in DAL

As we saw earlier, Citadel, Par Capital Management, Lansdowne Partners, and Iridian Asset Management increased their stakes in DAL in 2Q15. Citadel and Par Capital have held positions in the company since 1H11, when DAL traded at a 27% discount to its peers. Both hedge funds have been steadily increasing their positions in the airline since 1H11.


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