During this recovery period of passenger traffic, airlines and in particular Delta airlines (DAL) has been one of the biggest detractors. While not promising and overly delivered in normal times, it is a prudent management decision, such a move is not so wise in the midst of a virus crisis and investor panic. My investment thesis remains bullish because this airline and others provide too conservative guidance that allows for a huge advantage in business and related stocks.
Image source: Delta Air Lines website
Too conservative
Coming out of the low traffic levels of the crisis in mid-April, airlines provided guidance on second quarter daily cash consumption rates based on zero-income environments and disregarding Payroll Support Program grants of the United States Treasury. Airlines could easily have provided guidance based on a ramp of 10%, 25%, or even 50% of revenue levels, while including PSP funds to accurately reflect daily cash burn targets.
Now, three months later, the CEO of Delta Air Lines is back with the old tricks. Last week, CEO Ed Bastian proclaimed that summer revenue would only reach 25% of 2019 levels just three days before TSA traffic already exceeds 25%:
While it’s encouraging to see flights return, we expect our overall demand this summer to be just 25 percent of last summer’s revenue, and we’re likely to stay at least two years away from a return to normal.
Just a few days later, competitor United airlines (UAL) discussed plans to add 25,000 flights in August alone. The airline plans domestic hours at almost half of August 2019 levels with a total capacity of 40% of 2019 levels due to much lower international flights. The company sees demand rise 30% in July to 40% levels in August.
This brings us back to Delta, which is only forecasting 25% revenue levels here with United increasing capacity to 40% levels. When considering loyalty mile revenue offset by lower ticket revenue, one must consider revenue that almost equals capacity levels and why analysts have third quarter revenue estimates in 32% of 2019 levels.
Source: Looking for Alpha Profit Estimates
As previously mentioned, air traffic is already up to 25% of 2019 levels, even before the start of the third quarter. Certain states are issuing quarantine requirements from key travel destinations like Florida, but the assumption is that these moves only reduce the demand for travel on the sidelines. Travelers understand the virus better now, making it less likely that they will cut Florida’s weeklong vacation only because of the quarantine requirement (one that isn’t even really required) when daily deaths are at low levels. recovery despite new cases.
Worse still, perhaps, Delta continues to argue the road to normalcy taking at least two years. The biggest question is what an airline executive means by “getting back to normal.”
There is a big difference between a return to 80% of 2019 traffic levels, where airlines can have positive cash flow at reduced costs or a 100% return to last year’s levels. Even American Airlines Group (AAL) discussed a new normal in 2021 where international flights have still dropped 25% from peak levels. This new normal sounds more positive and much less serious than the two years for the Delta CEO to return to normal.
Cash burning evaporation
While Delta continues to predict some dire results every time the company talks to the media, the airline has already nearly eliminated the daily cash consumption rate. The airline ended in June only burning $ 30 million per day despite not originally forecasting large revenue growth for the period when cash burn fell from $ 100 million per day.
Source: Delta Air Lines presentation
A jump from 20% of 2019 income levels in June to 40% in August would add almost $ 630 million in additional monthly income. The amount equals ~ $ 21 million per day in additional income.
The airline is adding more flights, so variable costs like jet fuel and maintenance will increase, but the airline is already paying for employees to cover these additional flights. The big question is how to close the gap between PSP funds and excess payroll costs above 40% of capacity levels.
Once again, Delta’s management was overly conservative in providing liquidity guidance for the year at the annual meeting. While the airline projected to have more than $ 15 billion in liquidity by the end of the second quarter, management is only targeting $ 10 billion in liquidity at the end of the year. The warning to burn breakeven at the end of the year cannot occur while burning $ 5 billion in liquidity for the rest of the year.
This drop would require Delta to spend $ 28 million per day for the remainder of the year, which again is the management team that predicts a terrible outcome that is unlikely to occur. For the airline to reach cash breakeven by the end of the year, Delta would only spend about $ 2.5 billion in cash during the period, averaging $ 15 million per day. The airline is much more likely to end the year with $ 12.5 billion in liquidity.
The action has been affected since the spikes in early June due to concerns of a second wave of COVID-19 along with new spikes in cases in travel destinations such as Florida, Texas and Arizona. An important key to determining whether the airline’s stock recovers from the June lows is whether virus-related deaths soar. New cases took off in early June, however, deaths have been at a low since March due to a lack of new infections in the elderly. Without a jump in daily deaths, Delta Air Lines is likely to easily bounce back to the June highs of $ 37 and above.
To carry out
The key conclusion from investors is that stocks below $ 30 look ready to run here. The market will increasingly realize that the management team is overly conservative when the company provides financial estimates.
Delta Air Lines was a cheap stock at pre-virus highs above $ 60 and investors should eventually expect a return to those levels as the worst case result of COVID-19 is eliminated, and the biggest discussion is the level rebound in 2021 and beyond. For now, Delta appears ready to retest the recovery highs as daily cash burn rates drop to zero and the airline ends up with too much liquidity causing a recovery.
The stock is trading below 10 times current EPS ’21 estimates with a likely return to pre-virus EPS targets above $ 7 sooner rather than later.
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Divulge: I am / we are long AAL, UAL. I wrote this article myself and express my own opinions. I receive no compensation for it (other than Seeking Alpha). I have no business relationship with any company whose shares are mentioned in this article.
Additional disclosure: The information contained herein is for informational purposes only. Nothing in this article should be taken as a request to buy or sell securities. Before buying or selling any stock, you should do your own research and come to your own conclusion or consult a financial advisor. The investment includes risks, including loss of capital.
