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Delta Airlines, Inc. provides scheduled air transportation for passengers (>80% of total revenue) and cargo (3.5%) throughout the United States and across the globe. The company also owns a refinery in Philadelphia that produces and procures jet fuel for its airline operations. Delta Airlines is one of the largest airlines in the world, with a fleet of approximately 1,200 aircraft. The airline has a dominant passenger share in its core domestic hubs, including JFK, Boston, Los Angeles, and Detroit, also boasts an extensive international network, with significant market presence in Amsterdam, London-Heathrow, Mexico City, Paris and Seoul-Incheon.
Investment Overview
Most trusted US airline brand with a global network and strong foothold in the premium segment. Delta consistently ranks ahead of its domestic network peers in customer satisfaction/engagement surveys and independent third-party ratings by focusing on offering differentiated products catered to varying customer profiles and delivering best-in-class service and operational reliability. Consequently, this enabled Delta to gain market share over the course of the pandemic, particularly in its main US hubs and in the domestic corporate travel market. The airline’s success in de-commoditising its products and emphasis on the premium market led to an 8-10% unit revenue premium over the other US network carriers in the past year, with premium and non-ticket revenue now contributing to c.55% of the group's revenue.
Well positioned to benefit from the continued strong demand for long-haul, corporate travel and robust premium leisure demand; near-term operating margin in focus. Delta is poised for substantial earnings growth in the next two years, buoyed by the resurgence of corporate and international travel. While domestic passenger yields are under pressure, international passenger yields remain elevated and Delta emerges as a beneficiary on the back of its commanding international market share, particularly in the lucrative transatlantic routes to Europe. Further, with a strong foothold in the premium segment and exceptional cost discipline, the airline is in a better position to defend its margins in the face of rising costs stemming from higher pilot wages and sticky maintenance costs.
Medium-term growth supported by product premiumisation and loyalty program; strong free cash flows to enable share buybacks/dividends. Notably, Delta is optimistic on the rise of premium leisure and plans to sustain the share of premium in its revenue mix at 37% in the long run (FY23: 39%) via fleet reconfiguration and enhancing its premium offering. This shift will bolster Delta's medium-term operating margin, given the higher margins and consistent resilience of premium seats across economic cycles. Moreover, Delta's affiliation with American Express has vast growth avenues, especially since less than a third of SkyMiles members possess a co-branded credit card. Management projects the loyalty ecosystem's contribution to increase 10% y/y in FY24F from USD6.8bn in FY23. Overall, we view Delta’s FY24F targets of USD6-7 in earnings per share and USD3-4bn in free cash flow as achievable (translating to 5-7% FCFF to sales) and we are encouraged that management has reiterated its focus on dividend growth in FY24F as the airline is poised to meet its leverage targets by then, which should support its share price.
We have a BUY call on Delta with a TP of USD60.0. Our TP is based on 5.9x forward EV/EBITDA, pegged to 2 standard deviation above its 5-year mean prior to COVID-19. Currently, Delta trades at a forward EV/EBITDA of 5.0x, which is comparable to global peers. Nevertheless, we posit that Delta merits a premium relative to both its regional and international peers in light of its exceptional margin profile, its significant free cash flow prowess, and superior return on capital.
Risks
Macroeconomic weakness could curb discretionary spending on travel. Rising unemployment, coupled with slow wage growth among the general population and higher cost of living in the US could lead to households cutting back on travel spending. Corporate travel could take longer than expected to recover if companies could slash travel budgets because of economic woes.
Persistent cost inflation. Sustained volatility in crude oil/jet fuel prices (though Delta is in a slightly better position than peers because of its refinery operations), rapid wage growth of employees in the aviation sector, and other cost pressures could lead to earnings disappointment.
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