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Delta Air Lines Slumps: Time to Buy or Sell Airline Stocks?

Motley Fool - Fri Jan 19, 4:11AM CST

Delta Air Lines(NYSE: DAL) and other airlines are giving investors a classic conundrum in 2024. Do you buy a stock that seems to have excellent long-term value but has a significant amount of near-term risk?

For the budding Warren Buffetts of the investing world, the answer is usually "yes." But Buffett isn't the majority of investors, and many will balk at buying in. Here's what you need to know before purchasing.

Why Delta Air Lines Stock Slumped

There's no point tiptoeing around the elephant in the room. Delta's stock declined by nearly 10% on the day of its fourth-quarter earnings report, and peers like United Airlines and American Airlines declined a similar amount in sympathy.

In a nutshell, the market took a dim view of Delta's first-quarter and full-year guidance. Growth is slowing, nonfuel costs are rising, airlines continue building capacity, and Delta lowered its earnings and cash-flow expectations in 2024. The decline in the share price comes down to the headline numbers from updated guidance.

Delta Air Lines Guidance 2024

July

January

Earnings per share

>$7

$6-$7

Free cash flow

>$4 billion

$3 billion to $4 billion

Data source: Delta Air Lines presentations.

Growth is slowing and costs are rising

Growth is definitely slowing in the airline industry, and 2024 looks like a year when the recovery from the COVID-19 lockdowns will moderate to more normal growth levels. For example, Delta's management sees its first-quarter revenue up 3%-6%, compared to adjusted revenue growth of 11% in the fourth quarter of 2023 and 20% for the full year.

At the same time, its costs are rising. Management is expecting nonfuel cost per available seat mile (CASM-Ex) to rise by around 3% in the first quarter. With costs rising and revenue growth slowing, management forecasts an operating margin of just 5% in the first quarter, compared to 9.7% in the fourth quarter.

Putting it all together, investors are looking at a stock with a management that has just lowered full-year guidance and has rising costs and slowing revenue growth. It also has a lot of debt built up, due to the devastation wrought by the lockdowns and exposure to relatively high fuel prices.

It's also operating in a highly cyclical industry where profits can disappear at the drop of a hat. It's not hard to see why investor sentiment might be negative after the earnings report.

An airline passenger.

Image source: Getty Images.

Valuation is attractive, and so is the stock

Delta and other airline stocks face several headwinds in 2024, but keeping some perspective is essential. Airlines operate in a highly cyclical industry, but managements know this.

I stress this point to highlight that Delta's management has tended to be conservative in expanding capacity in the recovery -- as opposed to aggressively ramping up capacity, only to walk into an air travel slowdown. Indeed, CEO Ed Bastian told investors on the earnings call, "We plan to grow Delta's capacity 3% to 5%, below the mid-single-digit range that we discussed at our June Investor Day as we've refined our plan." This is a clear sign that Delta will take action to protect its margins.

Moreover, business surveys suggest corporate travelers intend to travel at least as much as they did in the first quarter as the fourth, and Bastian noted that executives from the tech industry were traveling again "and auto and entertainment sectors have rebounded nicely." That's good news for a carrier like Delta, which has increased its focus on the premium traveler in recent years.

A passenger at an airport.

Image source: Getty Images.

Moreover, based on management's guidance, the stock is attractive.

Let's put it this way: On the bottom end of management's guidance on earnings ($6) and free cash flow ($4 billion), the stock trades at 6.4x earnings and 8.3x free cash flow for 2024. For those worried about the company's $29 billion in adjusted debt (compared to a market cap of $24.75 billion), note that its adjusted debt to earnings before interest, taxes, depreciation, amortization, and rent (EBITDAR) ratio came down from 5x in 2022 to 3x in 2023. Management expects the ratio to fall to 2x to 3x in 2024.

A stock to buy?

Negative sentiment can definitely take the airline sector down, so don't be surprised if expectations get taken down further in 2024. That said, if Delta is close to the bottom end of its guidance at the end of the year and lower interest rates are improving the outlook for consumer discretionary spending in 2025, then the stock could be materially higher by the end of the year.

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Lee Samaha has no position in any of the stocks mentioned. The Motley Fool recommends Delta Air Lines. The Motley Fool has a disclosure policy.

Paid Post: Content produced by Motley Fool. The Globe and Mail was not involved, and material was not reviewed prior to publication.

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