Why Citigroup Says to Buy Delta Air Lines Stock

Delta Air Lines stock gained 1.7% on Friday after Citigroup analyst Stephen Trent suggested investors buy it. He initiated coverage on the stock with a bullish recommendation and a target price of $65. The analyst’s target price implies a 16% upside over the next year.

Why is Citigroup bullish on Delta Air Lines stock?

CNBC reports Trent is impressed with Delta’s (DAL) “revenue diversity, its relatively smooth earnings stream, and its solid alliance network.” Delta derives passenger revenue from several channels.

The company, known for its premium-class seating and amenities, continues to add premium seating capacity. The capacity brings double the fares as economy class. In the third quarter, the company’s premium product ticket revenue rose 9% YoY (year-over-year).

Moreover, the airline is focusing on driving revenue through non-ticket sources such as onboard food and services and baggage fees. Premium tickets and non-ticket sources contributed nearly 52% of Delta’s overall third-quarter revenue.

Trent is also impressed with Delta’s back-to-back quarters of robust bottom-line results. The company has surpassed analysts’ earnings estimates in the last nine quarters, and has recorded double-digit YoY earnings growth in the last five.

Additionally, Trent sees its alliances with other airlines and companies boosting its financials in the long run. On September 26, Delta announced a $2.25 billion partnership with LATAM Airlines. According to the contract, the company will buy a 20% stake in LATAM for $1.9 billion and invest an additional $350 million.

The investment would help Delta expand across Latin America and compete with American Airlines (AAL). American Airlines has a strong presence in South America through its partnership with LATAM Airlines. Delta projects the LATAM collaboration will be accretive to its earnings over the next two years.

Trent’s views differ from other analysts’

Trent’s “buy” rating for Delta is surprising. Many other analysts have downgraded the stock and lowered its target price since its third-quarter earnings release on October 10. Following the release, Argus Research and Stephens downgraded Delta stock to a “neutral” equivalent from a “buy” equivalent. Stephens also cut its target price by 24% to $57. Raymond James and Buckingham Research have trimmed their target prices by $6 and $2, respectively, to $64 and $56.

Most analysts have raised concerns about rising costs and pricing pressure hurting Delta’s profitability next year. Bernstein forecasts that higher maintenance costs, wages, and tariffs could impact Delta’s earnings.

Delta’s third-quarter results also signaled rising costs and pricing pressure. The company’s third-quarter non-fuel expenses rose 2.4% YoY, mainly because of higher wages and costs due to unfavorable weather.

Buckingham Research analyst Daniel McKenzie also fears the airline’s non-fuel expenses could rise next year due to increased labor costs. He has warned that the company could face pricing pressure once Boeing’s (BA) 737 MAX aircraft return to service.

The MAX flying ban since March has cost airlines millions of seats. Together, Southwest Airlines (LUV), American, and United Airlines (UAL) own 72 MAX planes. The grounding has caused nearly 50,000 flight cancellations for the carriers. Citing these challenges, McKenzie downgraded Delta stock on October 3 to “neutral” from “buy,” and cut its target price by 22% to $58.

Analysts’ recommendations and target price

A month ago, about 70% of the 20 analysts covering Delta were bullish. That proportion has reduced to 62%, and analysts’ average target price for the stock has fallen 5.5% to $64.37. Their average target implies an approximate 15% upside over the next year.

With a year-to-date return of 12.3%, Delta stock has underperformed broader US indexes and the iShares Transportation Average ETF (IYT). The Dow Jones, Nasdaq, and S&P 500 are up 17.2%, 26.4%, and 22.3%, respectively, this year. Meanwhile, IYT, of which about 20% is allocated to the passenger airline industry, has gained 16.8%.