Will Delta Benefit from Partnership with LATAM?

On Thursday, Delta Air Lines (DAL) announced a partnership with LATAM Airlines in a deal worth $2.25 billion. According to the agreement, Delta will acquire a 20% stake in LATAM for $1.9 billion. Also, the company will invest an additional $350 million to help LATAM transition out from Oneworld alliance and join Delta’s SkyTeam network.

Delta and LATAM partnership

As part of the deal, Delta will purchase LATAM shares through a tender offer at $16 per share. The transaction would allow Delta to be on LATAM’s board of directors. Also, the airlines would acquire four long-haul and wide-body Airbus A350 aircraft. The partnership assumes that LATAM will fulfill its commitment to buy ten additional A350 planes. LATAM will receive the shipment between 2020 and 2025.

Will the partnership impact American Airlines?

Delta’s aggressive approach towards enhancing the South American network will help it compete with American Airlines (AAL) in the region. Notably, American Airlines has a strong presence on the continent through its partnership with LATAM Airlines. Currently, the airline has the highest number of fleets between the US and South America. As a result, we think that the Delta-LATAM partnership will disrupt American Airlines’ business operations in the Latin American region.

The Delta and LATAM collaboration is the second major blow for American Airlines in the region this year. Earlier, the Chilean Supreme Court stopped American Airlines and LATAM Airlines for more route cooperation. The court’s ruling limited the upside benefits for the American Airlines and LATAM partnership. Due to LATAM’s new arrangements with Delta, American Airlines will likely lose its market share in the region.

However, American Airlines denied that there’s a major financial impact from the Delta and LATAM collaboration. In a statement on Thursday, American Airlines said that “this change in partnership is not expected to have a significant financial impact to American, as the current relationship provided less than $20 million of incremental revenue to American, and the proposed joint business without Chile would have provided limited upside,” according to One Mile at a Time.

Financial benefits 

Delta expects its investment in LATAM to increase its EPS over the next two years. The company expects the deal to bring in an additional $1 billion in revenues over five years. In a press release, Delta stated that the LATAM deal won’t impact its financial commitments to shareholders.

LATAM Airlines expects the transaction to improve its capital structure by reducing its debt of $2 billion by 2025. The company expects the deal to enhance its free cash flows and help it execute long-term strategies better.

Delta expands its international operations

Delta has been expanding its global operations through partnerships. The company has made equity investments in several companies including Air France-KLM, Grupo Aeromexico, Korean Air, Virgin Atlantic, and China Eastern Airlines.

Recently, the company increased its equity stake in Korean Air’s parent company Hanjin Group to 9.2%. Delta has 49% equity ownership in Mexico’s largest carrier, Aeromexico. The company has an 8.8% stake in Air France-KLM. Meanwhile, Delta holds 49% of the Virgin Atlantic shares. In addition, the company has a 3.6% equity stake in China Eastern Airlines.

Delta’s strong balance sheet and robust cash flow generating capability help it make aggressive investments. At the end of the second quarter, the company had cash and cash equivalents of $2 billion. In the first half of 2019, Delta generated an operating cash flow of $5.2 billion and a free cash flow of $2.5 billion.

The company is building partnerships in other areas to boost its revenues. In April, the company renewed its credit card alliance with American Express (AXP) for 11 years. Notably, the two companies have a 23-year old business relationship. Delta expects that renewing the credit card agreement will bring in an additional $7 billion through 2023.

Delta’s YTD stock performance

So far, Delta stock has been one of the top performers in the airline industry this year. The stock has gained 17.8% YTD (year-to-date). Delta has outperformed the Dow Jones’ 15.3% gain. The company’s YTD return is also higher than the iShares Transportation Average ETF’s (IYT) gain of 13.3%. IYT has allocated nearly 21% of its fund to the passenger airline industry.

In contrast, most of Delta’s peers struggled to keep pace with the broader market. Spirit Airlines (SAVE) and American Airlines have struggled the most in the airline industry. The stocks have lost 36% and 15% of their respective market capitalization YTD. Meanwhile, United Airlines (UAL) stock has risen 5.6% YTD.

Overall, analysts’ target price suggests that Delta still has upside potential left in its share price. The average target price of $70 shows a return of 19% over the next year. The analysts polled by Reuters provided a consensus “buy” recommendation of Delta stock. Among the 20 analysts, 75% have a bullish stance on the stock, while the remaining 25% recommend holding the stock.