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Can Delta Air Lines Keep Its Earnings Surprise Streak Alive?

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Second-quarter expectations

Delta Air Lines (DAL) is scheduled to report its second-quarter results on Thursday. The company is the largest US airline based on market capitalization. Delta has a strong record of beating analysts’ earnings estimates. The company has beat analysts’ earnings estimate in the previous seven quarters with an average positive surprise of 4.3%.

Delta registered double-digit earnings growth in the last three quarters. Analysts’ earnings forecast suggests that the trend will continue in the second quarter. For the second quarter, analysts project an adjusted EPS of $2.26 for Delta, which implies a rise of 27.4% YoY (year-over-year). Analysts think that higher revenues, cost-cutting measures, and moderate fuel costs will be the key growth catalysts for second-quarter bottom-line results.

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Management’s guidance

On July 2, Delta raised its second-quarter outlook due to strong passenger demand. For the second quarter, Delta registered traffic growth of 6.3%, while its capacity increased 4.7%. The company carried a record ~54 million passengers during the quarter.

Delta expects its revenues to grow 8%–8.5% YoY compared to its earlier guidance range of 6%–8%. Analysts’ revenue estimates of ~$12.5 billion coincide with the upper end of management’s updated guidance range. The company expects the total revenue per available seat mile to grow at the high end of its previous outlook range of 1.5%–3.5%. Delta expects the total revenue per available seat mile to reach 17.37 cents from 16.78 cents in the second quarter of 2018.

We think that Delta’s top-line results will benefit from its renewed credit card partnership with American Express (AXP) in early April. The company said that its first-quarter unit revenues benefited by one point due to the renewed agreement.

We expect the partnership to continue to benefit Delta in the second quarter. The company’s 23-year collaboration with American Express has helped it diversify its revenue streams. According to Delta, the credit card agreement helped it generate an additional $3.4 billion in revenues in 2018. The revenues could double to $7 billion in 2023.

Delta’s management expects its second-quarter pre-tax margin to be 15%–16% compared to the previous guidance range of 14%–16%. The company’s second-quarter EPS is expected to be $2.25–$2.35, which is higher than its earlier guidance range of $2.05–$2.35. Delta’s new EPS guidance range depicts 27%–33% growth YoY.

Delta’s cost control measures, fleet transformation, and One Delta initiatives will likely continue helping it efficiently manage non-fuel expenses. The company expects its non-fuel unit cost to rise 1%–2% in the second quarter to 10.10 cents–10.20 cents.

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Lower fuel costs to drive earnings

We think that moderate oil prices in the last quarter should benefit Delta’s bottom-line results. Oil prices have been slightly more economical in the second quarter compared to the second quarter of 2018. According to data compiled by the Federal Reserve Bank of St. Louis, the average WTI oil price in the second quarter was ~$59, which is ~13% lower than ~$68 in the second quarter of 2018.

Fuel is a significant cost component for airlines. A decline in crude oil prices could boost Delta’s profitability in the second quarter. The company has also lowered its average fuel cost per gallon cost range to $2.07–$2.12 from $2.10–$2.20 it anticipated previously. Delta’s second-quarter estimates are also lower than the average fuel cost of $2.17 per gallon that it incurred during the second quarter of 2018.

Stock performance

Delta is the top performer among US airlines. Consecutive quarters of strong financial results are driving the stock higher. The stock has gained 17.6% this year. Delta has outperformed the Dow Jones and the iShares Transportation Average ETF (IYT), which have risen 15.4% and 14.3%, respectively. IYT has allocated 19% of its fund in the US passenger airlines.

Delta stock has outpaced other major US air carriers’ returns. Southwest Airlines (LUV), United Airlines (UAL), and American Airlines (AAL) shares have risen 11.6%, 8.2%, and 1.1%, respectively.

Despite impressive YTD gains, analysts still expect double-digit upside potential in Delta stock over the next year. Analysts’ consensus target price of $67.22 suggests a 14.2% upswing in the stock price from the current level of $58.70.

On the valuation front, Delta is trading at relatively cheaper multiple than its peers. Currently, the stock trades at 9.8x its PE ratio—a significant discount to the industry average of 12.3x. Southwest Airlines, United Airlines, and American Airlines have PE ratios of 12.3x, 10.9x, and 10.6x, respectively.

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