It has been clear from day one that airlines would be some of the biggest beneficiaries of tax reform. Most airlines pay close to the statutory tax rate today, whereas many companies in other industries benefit from big tax breaks. In addition, airlines have huge fleet-related capital costs, which will get favorable tax treatment for the next several years.
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Last week, Delta Air Lines (NYSE: DAL) provided fairly detailed guidance for how it would be affected by the proposed tax law changes. Not surprisingly, it expects to reap significant savings on its income statement. The tax bill will dramatically reduce its cash tax payments as well.
Earnings per share will soar
At its investor day last week, Delta Air Lines provided forward earnings guidance for the first time. The company expects to generate adjusted earnings per share of $5.35-$5.70 in 2018, up about 10%-15% year over year.
This base case would already be a good outcome for Delta shareholders. However, the company noted that EPS will be significantly higher if the tax reform bill goes into force next year.
Based on management's recent estimates, Delta Air Lines' book tax rate would fall to 22%-24%, whereas it has been around 35% recently. This drop would increase EPS by $1.00-$1.25, a 20%-plus incremental gain. (Delta's analysis assumed a 20% corporate tax rate; the revised bill calls for a 21% rate, which would slightly reduce the EPS benefit.)
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There's also a cash windfall
Even more importantly, Delta Air Lines expects the new tax bill to reduce its cash tax burden, because of provisions that will allow the company to immediately deduct the cost of its aircraft purchases from its taxable income.
Delta Air Lines hasn't been paying any cash taxes in recent years, due to its accumulated losses from the 2000s. However, Delta has been projecting that it would start to owe cash taxes in 2019. The tax reform bill would allow it to push off its first cash tax payments to 2020.
Indeed, Delta is in a particularly good position to benefit from the tax bill's provisions for "full expensing" of capital investments, because it has one of the oldest aircraft fleets in the country.
As of the end of September, Delta was already committed to spend about $12 billion on new aircraft between 2018 and 2022, mainly from Airbus (NASDAQOTH: EADSY). These happen to be the years for which full expensing will be permitted. (This benefit will phase out gradually between 2023 and 2027.) In addition, Delta recently agreed to buy 100 Airbus A321neos between 2020 and 2023, further increasing capex.
Once the proposed bill becomes law, Delta could order additional aircraft. It may exercise some of its 100 A321neo options with Airbus. The carrier could also expand its existing orders for A330neos and A350s, which will replace the oldest widebodies in its fleet. The tax bill effectively subsidizes aircraft purchases for the next few years, so Delta has an incentive to accelerate its fleet renewal project.
This stock looks cheap
Shares of Delta Air Lines currently trade for about 10 times the company's official 2018 EPS guidance. But incorporating the potential impact of tax reform, the stock trades for just a little more than eight times forward earnings.
The cash benefits of tax reform should bolster Delta's EPS growth beyond 2018. If the carrier starts buying more planes from Boeing and Airbus to accelerate its fleet renewal, it will benefit from huge fuel efficiency gains and significant maintenance cost savings. Alternatively, if it stands pat, it will be able to use the cash savings from lower tax rates to buy back more stock.
Either way, Delta Air Lines stock looks undervalued, even though it is trading near an all-time high. As a result, I plan to continue holding my Delta shares for the foreseeable future.
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