January has already seen impressive gains in broader markets, and shareholders in the Atlanta-based airline Delta (NYSE:DAL) stock have also enjoyed a year-to-date gain of about 6%.
In the U.S, four major carriers — American Airlines (NASDAQ:AAL), United Continental Holdings (NASDAQ:UAL), Delta and Southwest Airlines (NYSE:LUV) — control about 70% of the domestic market. Furthermore, prices of airline stocks — including DAL — have strongly increased over the past decade.
If you had invested $1,000 on Delta shares in mid-January 2010, you would now have about $5,270. This change equates to more than 18% in terms of the compound annual growth rate (CAGR). And the calculation does not take into consideration the actual dividend or further return through the reinvestment of that income.
Now, investors are wondering whether the growth story of Delta stock may take a pause, or if they should stay invested Delta shares. Although I believe DAL stock is a good long-term investment, there is likely to be short-term profit-taking in the airline.
With that said, let’s take a closer look.
A Closer Look at Delta Stock’s Recent Earnings
On Jan. 14, Delta stock reported fourth-quarter earnings that exceeded expectations. Revenue reached $11.4 billion, a 7% year-over-year increase. Additionally, adjusted earnings per share came at $1.70, a 31% increase YoY, and it was above the guidance of $1.20 to $1.50
This year, the International Air Transport Association (IATA) expects 1% of global GDP to be spent on air travel. Over the next two decades, the forecast also anticipates about 3.5% CAGR growth. A strong economy, low unemployment and increased consumer spending both in the U.S. and worldwide have been the recent tailwinds for the industry.
Another reason for the airline’s strong earnings has been the fact Delta doesn’t fly Boeing’s (NYSE:BA) 737 MAX. Therefore, the group has not been affected by various adverse developments following the two crashes of the aircraft.
Looking forward, Delta management now anticipates an annual revenue growth of 5% to 7% in Q1 2020.
Latin American Developments Could Be a Further Catalyst
When evaluating stocks, in addition to looking at various fundamental metrics, I also pay attention to possible future changes and trends within a geography or society.
Last year, Delta announced an upcoming partnership with LATAM Airlines Group (NYSE:LTM). This will involve an investment of $1.9 billion by Delta in common shares of LATAM, as well as an additional $350 million to support the partnership.
In 2012, LAN Airlines and TAM Linhas Aereas had merged to form LATAM Airlines. The Chile-based group now serves 146 destinations in 26 countries, operating more than 1,300 flights a day and transporting 69 million passengers per year. In other words, LATAM’s management has been able to increase operational efficiencies through this merger, and created a brand that has caught the attention of Latin American customers.
Now eight years later, Delta is able to access routes to South America that wouldn’t have been possible without the partnership.
As travel demand in Latin America grows due to demographic developments, LATAM will be in a robust position to capitalize on its current market dominance. And that long-term growth should bode well both Delta and LATAM stocks.
Valuation and Dividend Are on the Side of Delta Stock
Despite the decade-long increase in the price of DAL shares, Delta stock currently trades at a forward price-earnings ratio of 8.5 — a number that should catch the attention of value investors. In other words, the price appreciation is well-deserved.
In November 2016, Warren Buffett’s Berkshire Hathaway (NYSE:BRK.A, NYSE:BRK.B) revealed that the group had taken a stake in the four major domestic airlines. At the time, this rather unexpected investment by the legendary investor had brought the industry into the limelight.
Moreover, in March 2019, Berkshire Hathaway upped its investment in Delta stock. So if Buffett believes in DAL stock long-term, maybe you should too.
And, anyone who buys Delta shares can enjoy dividend income, which now stands at a yield of 2.6%.
Also, the airline has plenty of cash, as its adjusted free cash flow (FCF) hit $4.2 billion in 2019. Management is confident of generating similar FCF in 2020, and therefore, the annual cash flow would strong enough to cover current payouts and future dividend raises.
As the name implies, the airline would be “free” to do whatever it wants with this free cash flow. Most companies would decide to return a good portion of it to investors. Indeed, earlier in 2019, Delta had increased its quarterly dividend by 15%. Could we possibly expect a similar dividend increase from the airline in 2020 or by 2021 at the latest?
What Could Derail Delta Stock in 2020?
Many analysts regard transportation companies, such as Delta, as the backbone of an economy.
There are several crucial drivers of change that affect the industry, as well as airline management. These factors include:
- Societal developments, such as urbanization and demographic changes.
- Economy, such as the price of oil, business cycles and volatility.
- Technology, such as aircraft development, cybersecurity or the role of social media in customer engagement.
- Environment, such as regulation of emissions and noise pollution.
- Politics, such as regulatory changes, trade protection and response to terrorist threats.
Within this context, airlines such as Delta are under constant pressure to improve performance, ensure passenger safety, increase efficiency, become technologically advanced and — at the same time — excel in customer satisfaction.
Overall, the economics of running an airline like Delta are quite complex. However, at the end of the day — like any other company — DAL stock needs revenues to cover operating costs and become profitable.
Delta stock’s two largest operating costs are fuel and labor. In 2020, if there is an unexpected and permanent increase in the price of oil, then DAL shares may suffer.
Currently, the international benchmark Brent crude is hovering around $64. Yet, over the past 20 years, the price of oil has fluctuated between from as low $28 per barrel to as high as almost $165.
Therefore, long-term DAL stock investors would need to keep in mind that the airline industry is cyclical — meaning profits could stall or drop in a slowing economy. And oil prices do matter for Delta stock.
The Bottom Line on DAL Stock
I believe Delta is a solid income and value stock to round out long-term portfolios.
Yet, as the earnings season gets underway in the coming weeks, I expect volatility in broader markets that may also affect the price of DAL stock.
Also, Delta’s technical momentum indicators — which describe the speed at which prices move over a given period — are currently in overbought territory. Although these indicators can stay overbought for quite a long time, short-term profit taking in the company’s stock is probably around the corner.
There could easily be a move back below $60 in Delta stock in the near future. However, long-term investors may regard any such dip as opportunity to buy into the Delta share price.
As of this writing, Tezcan Gecgil did not hold a position in any of the aforementioned securities.