Delta Air Lines (NYSE: DAL) stock got whacked last Thursday, falling 5% as investors digested information from the company's 2018 investor day. Delta shares now sit more than 13% below the all-time high they reached late last month.
Investors were probably spooked by a combination of Delta's revenue outlook -- which implies a continued slowdown in unit revenue growth next year -- and a 2019 earnings-per-share forecast that is below the average analyst estimate at the midpoint. Yet behind the noise, Delta Air Lines gave shareholders a lot of reasons to be confident about the future. Let's take a look.
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The short-term forecast grabs the headlines
For 2019, Delta Air Lines projects that revenue will rise 4% to 6% year over year. That would be significantly less than the 8% top-line growth it expects to report for 2018.
Given that Delta plans to grow capacity by about 3% next year, its revenue forecast implies that revenue per available seat mile (RASM) will increase 1% to 3% in 2019. For comparison, RASM rose 4.6% through the first three quarters of 2018 and is on track to increase 3.5% this quarter. Thus, the investor day presentation seemed to confirm investors' fears that unit revenue growth is suddenly slowing.
Furthermore, Delta estimated that EPS will come in between $6 and $7 next year. That would comfortably exceed the $5.58 that analysts expect for 2018, but it represents a slight letdown relative to the 2019 analyst consensus of $6.70.
The outlook may be better than it seems
Investors may be taking Delta's guidance too literally, based on their knee-jerk reaction to the investor day presentation.
First, Delta's forecast for top-line growth in 2019 is the same as the 2018 outlook it shared a year ago. Delta Air Lines has comfortably beaten the high end of its guidance for 4% to 6% revenue growth this year. This suggests that its 2019 revenue guidance may be conservative, although it is important to acknowledge that the airline will face tough year-over-year comparisons next year due to its strong 2018 performance.
Second, Delta is definitely staying conservative with its fuel cost forecast. Its EPS guidance assumes an average Brent crude price of $65 to $70 per barrel next year, whereas Brent crude futures have been trading for close to $60 per barrel recently. Using current market prices rather than Delta's more conservative assumption (and holding everything else constant) would boost the midpoint of the company's 2019 EPS outlook by approximately $0.80.
Third, Delta is projecting strong profit growth next year despite a $200 million-$250 million year-over-year pre-tax headwind from pension costs. This pension headwind reflects the fact that the company has been using overly optimistic estimates of future returns on its pension assets up until now. However, Delta's pension deficit -- arguably a more important metric for investors to track -- had actually declined from around $7 billion at the end of 2017 (and $10.6 billion a year earlier) to $5.5 billion as of the end of September.
Building a more resilient business
Shareholders frequently focus on the details of a company's forecast for the upcoming year, but long-term investors should pay more attention to changes in its overall competitiveness. From this perspective, Delta had some very good news for investors.
First, Delta Air Lines pointed out that it now gets just 48% of its revenue from sales of main cabin and basic economy tickets, down from 63% in 2011. The majority of revenue now comes from a combination of premium seats, its co-branded credit card program, cargo, and various ancillary revenue streams.
Not only does this mean Delta has a more diversified top line, it also marks a shift in its revenue base away from the most commoditized products (coach seats) toward more distinctive offerings that should not be subject to the same level of cutthroat price competition.
Second, Delta expects adjusted nonfuel unit costs to rise just 1% in 2019 as its three-year cost-cutting program starts to pay off. The carrier expects to reap even greater savings in 2020, which could potentially allow it to hold nonfuel unit costs flat in that year. (An aggressive plan to replace the oldest planes in its fleet will also help reduce unit costs.)
In short, Delta is on track to report another year of strong earnings in 2019, and its moat continues to widen as it moves away from a reliance on selling coach fares. With the stock trading for just eight times the midpoint of management's 2019 EPS guidance, Delta Air Lines is definitely worth a look for long-term investors.
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