Krause Fund Research Spring 2016 Consumer Delta Air Lines, Inc. (NYSE: DAL) Discretionary Recommendation: Hold April 19, 2016 Analysts Current Price 46.55 Target Price $50 - $56 Eric Hale [email protected] Nick Steingreaber DAL Exhibits Consistent Results [email protected] • Delta cannot lower ticket prices as drastically as competitors Company Overview who have better hedging positions. Therefore, Delta will struggle to reap the full benefits of the low oil prices before Delta Air Lines, Inc. (NYSE:DAL) has proven to be a global prices will likely rise again in the near future. We expect Delta leader within the airline industry. Primarily, Delta provides to experience temporarily decreased margins before the value through domestic flights, but also offers international industry’s cost of goods sold playing field is leveled again. flights. Internationally, Delta segments revenue through Pacific, Atlantic and Latin American flights. If there is capacity on the • Heavy expansion into the Latin American market as well as plane, Delta will also ship cargo as an additional source of optimization efforts in the Atlantic segment will drive revenue revenue. For the fiscal year ended 12/31/15, Delta’s total and earnings. The increased earnings per share may allow Delta passenger revenues totaled just over $34BB and total operating to increase dividends, but we expect EPS to stabilize at a level revenue rose 0.85% to $40.7BB. that does not generate an outstanding competitive advantage. Investment Thesis • The demand for airline tickets will always be present because of the convenience that air travel provides. So, we Delta is known for providing reliable air travel, exceptional believe that the airline industry will eventually rebound from customer service and convenience for consumers. The company low margins. While the company will inevitably last, the lack of has solidified itself as a top player in the airline industry by capitalization on current economic trends speaks to a hold rating. surviving various airline bankruptcies and economic downturns. Recently, oil prices have dropped to prices that have not been Financial Ratios seen in over a dozen years. Though Delta’s management has Current Ratio 0.52 been working to renegotiate hedging contracts to have access to Debt to Equity 0.77% cheaper fuel, Delta still has one of the worst hedging positions in the industry. Delta will struggle to lower ticket prices and spur Stock Performance Highlights demand because margins are already low, but the company will 52 week High $52.77 rely on expansion efforts, customer service and infrastructural 52 week Low $34.61 reliability to continue to drive revenue growth into the future. Beta Value 1.31 Average Daily Volume 9.83 MM One Year Stock Performance Share Highlights Market Capitalization $36.24 BB Shares Outstanding $797 MM Book Value per share $13.61 EPS (FY ‘15) $5.68 P/E Ratio 8.27 Dividend Yield 1.09% Dividend Payout Ratio 7.92% Company Performance Highlights ROA 8.44% ROE 46.04% Sales $40.7 BB 1 Important disclosures appear on the last page of this report. Executive Summary We recommend a HOLD rating on Delta Air Lines, Inc. (NYSE:DAL) as of April 19th, 2016. Evaluating Delta’s discounted cash flows and placing heavy emphasis on the price to equity ratios of Delta’s peers, we have concluded that Delta’s target price is $51 - $56. The domestic flight will continue to be the major driver of revenue, but there will be a saturation of the domestic market which will lead to expansion into other markets. Delta also is able to maintain relevancy by relying on subsidiaries and joint ventures that span over 57 countries and six continents. (21) Further, Delta will continue to turnover the current fleet of Source: Fred Economic Data (2) airplanes to provide the utmost level of efficiency and customer satisfaction. Additionally, Delta will need to address the rise of low cost carriers and try to maintain their favorable market Consumer Confidence share. Consumer confidence, a gauge of consumer’s feelings on the Delta has sustained major industry consolidation and has economy, political stabilization, and future outlook for their maintained industry leading on-time rates. So, we have deduced financial health is one of the most important indicators to look at that Delta will continue to be a top presence within the airline when forecasting the future of airline ticket sales. When industry. However, we believe that the current low oil prices will consumer confidence is high, the average consumer feels that incentivize Delta to lower ticket prices, slashing margins when their future financial health is stable or rising and is therefore oil prices inevitably rise. Expansion into underutilized markets more likely to spend money on discretionary items. The specific will allow the company to hedge against the margin losses as a value of the consumer confidence index is not as important as result of rising oil price but will not be significant enough to the general trend of the index. Looking at the trends of the index, justify a BUY rating. the U.S. consumer, over the last year, is near its most confident level since Q4 2006. Macroeconomic Outlook Gross Domestic Product The real gross domestic product (GDP) is a measure of the goods and services produced in a country during a given period of time, after adjusting for inflation. GDP is an important statistic to look at because it reflects the state of the economy fairly accurately. This is important because consumers are more likely to spend money on “discretionary” items such as automobiles, vacations, and other luxury goods when the economy is doing well and they have excess money to spend. (1) Since the financial crisis of 2009, parts of the economy have been recovering rapidly, but GDP growth has been stagnant Source: U of Michigan, FRED Economic Data (3) between 1.5% and 2.5% over the last six years. Our team believes that while Real GDP is usually a good indicator for Looking at the consumer confidence levels, it should not be a discretionary sales, other indicators such as consumer surprise that 2015 was a strong year for the airlines. When confidence, interest rates, oil prices, and employment statistics consumers are confident that they are in a financially stable are currently better indicators because they are measurements environment they are more likely to take on risk (debt) than if and indicators that are more closely related to consumers. they were unsure about their job security, political instability or future inflation rates. Going forward, our estimate for 2016 GDP growth is 1.8% because of headwinds from rising interest rates and the We believe that the slight downtick in the consumer confidence economic uncertainty that has led the S&P 500 index into a near index in January and February were reflections of the poor 14% decline from its 2,100 level in October, 2015 before equity market performance and expect that consumer confidence rebounding in March 2016 to 2,094 as of April 18, 2016. In will rise to its 2015 highs in 2016. This is important to our addition, a global downturn has strengthened the U.S. Dollar and model because we expect North American air transportation to hurt exports. remain steady. 2 Important disclosures appear on the last page of this report. Interest Rates Gasoline may be one of the largest expenses a household has and is definitely one of the most visible and volatile. We believe that The US and global economies are in a peculiar time for lower gasoline prices are one of the reasons that consumer monetary policies. Never before has the world seen such confidence has been so high over the last year. The lower gas intervention by central banks to influence interest rates around prices put more money into consumer’s pockets and make them the world. The US Fed raised its Fed Funds rate by 0.25%, from better off financially. This, in turn, raises the consumer 0.25% to 0.5%, in December 2015. Originally, the Fed stated confidence index. With the US personal savings rate at only that it intended to raise its rates by 0.25% four times in 2016. 5.5%, it leads us to believe that 94.5% of the money saved at the (5) However, with the early volatility in the markets the Fed has pump is being spent in the economy. Since this is excess backed away from that stance and failed to raise rates in March. money that a consumer probably did not budget for, it is more Fed Chairwoman, Janet Yellen, has also seemed to take a more likely that they will spend it on discretionary items such as dovish stance on raising rates and signaled that the Fed now vacations and airline tickets. We believe that the combination of plans to do so only twice during 2016. As the graph shows, a 10- a high consumer confidence index and low jet fuel prices is a year treasury note yielded about 5% before the recession but major indication that airfare ticket sales will continue to increase now yields only 1.8%. This marked decrease in interest rates over the next year. have propelled the recovering economy forward, but if the Fed waits too long, inflation could get out of control and put the U.S. Oil will continue to be volatile throughout 2016, but will not right back into a recession. begin to make significant price movements upward until Q2 2017. We believe this because of our analysis of oil production and demand. The below EIA graph shows this imbalance between supply and demand.