Do winter storms make airlines like DAL a risky bet?

January 21, 2019

Do winter storms make airlines like DAL a risky bet?

This last weekend, one of the headlines that grabbed my attention was about winter storms in the Midwest. Of course, at this time of year it doesn’t come as any kind of big surprise to hear or read about snow, cold or big storms in that part of the country; but any investor with an interest in paying attention to things that can impact the stock market should have sat up and taken notice by the accompanying report that more than 1,100 flights were cancelled out of Chicago by Saturday afternoon.

Chicago is a major hub of airline activity; flights from either coast stop there before continuing on their way, and of course the city is itself a destination of interest. So when severe winter weather can practically shut down one of the biggest airline hubs in the United States, the next natural question that any sensible investor should start asking is what kind of impact that is going to have. We are talking right now about just one weekend’s worth of delays, but even so, that means that airlines will have to absorb additional costs, ranging from ticket refunds to paid hotel accommodations – and that’s just thinking of a couple of things off the top of my head.

Can something like a single weekend’s winter weather cause a major impact on the entire economy? I’m not so certain; but extended periods of cold weather can have a ripple effect that extends well beyond a single industry or area of the economy. Last spring, for example, home improvement stores reported sales numbers that generally disappointed investors, and attributed much of the cause to the effect of extended winter weather that kept homeowners from starting new projects. So if this last weekend’s weather becomes part of a more extended pattern throughout the colder areas of North America, it isn’t unreasonable to suggest that winter weather could be a drag on the economy moving into the warmer months of the year.

I think the biggest risk is in the short-term, and is mostly localized to the airline industry. It isn’t coming at a great time, as the Transportation sector as measured by the iShares Transportation Average ETF (IYT) has been rebounding off of 52-week lows that saw sector drop nearly 28% of its late 2018 highs. Since late December, the sector is up almost 16%; but last weekend’s news could put a lid on that rally and force the sector to retest those lows.

Airlines are among the most cyclical stocks in the entire stock market; they are sensitive to movements in oil prices, to consumer sentiment, and to interest rates. It isn’t a stretch, then to suggest that the kind of news that came out of Chicago this weekend is likely to weigh on the industry in the early part of this week at least. That means that some of the biggest names in the industry, like Delta Air Lines Inc. (DAL), United Continental Holdings (UAL) and American Airlines Group (AAL) could be pretty risky plays right now.

DAL is an interesting stock in the industry, because they have a solid fundamental profile, and have been trailing the sector and the industry for the past month. After reaching a high point in November of last year, the stock is down almost 22% as of Friday’s close. It is also down year to date, while most of its competitors, and the Transportation sector in general is up over the same period. That could offer some tempting value bait for a bargain-hunting investor; but is the potential reward worth the short-term price risk? 

Fundamental and Value Profile

Delta Air Lines, Inc. provides scheduled air transportation for passengers and cargo throughout the United States and across the world. The Company’s segments include Airline and Refinery. The Company’s route network is centered around a system of hub, international gateway and airports that the Company operates in Amsterdam, Atlanta, Boston, Detroit, London-Heathrow, Los Angeles, Minneapolis-St. Paul, New York-LaGuardia, New York- John F Kennedy International Airport, Paris-Charles de Gaulle, Salt Lake City, Seattle and Tokyo-Narita. Each of these operations includes flights that gather and distribute traffic from markets in the geographic region surrounding the hub or gateway to domestic and international cities and to other hubs or gateways. The Company’s route network includes its international joint ventures, its alliances with other foreign airlines, its membership in SkyTeam and agreements with multiple domestic regional carriers that operate as Delta Connection. DAL’s current market cap is $33 billion.

  • Earnings and Sales Growth: Over the last twelve months, earnings grew by almost 35.5%, while revenues increased by nearly 5%. In the last quarter, earnings decline almost -28%, while sales dropped by more than -10%. The company operates with a healthy margin profile, with Net Income running at 8.78% of Revenues for the last twelve months, and increasing to almost 9.5% in the last quarter.
  • Free Cash Flow: DAL’s free cash flow is healthy, at more than $2.5 billion. That translates to a Free Cash Flow Yield of 7.86%.
  • Debt to Equity: DAL has a debt/equity ratio of 1.03. This number number has increased over the last couple of quarters, but the company’s balance sheet shows that operating profits are adequate to services their debt. The company has about $1.7 billion in cash and liquid assets as of the most recent quarter against $8.2 billion in debt, which does verify that like most airline stocks, DAL is pretty highly leveraged.
  • Dividend: DAL pays an annual dividend of $1.40 per share, which translates to a dividend yield of about 2.91% at the stock’s current price.
  • Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value, which for DAL is $19.95 per share. That number also translates to a Price/Book ratio of 2.41 at the stock’s current price. Their historical average Price/Book ratio is 3.06. That suggests the stock is trading right now at a discount of almost 27%, which is pretty attractive. The stock’s Price/Cash Flow ratio is about 23% below its historical average, which means that the long-term target price is between $59 and $61 per share. That’s not too bad – if you’re willing to accept and ride through some additional short-term turbulence.

Technical Profile

Here’s a look at the stock’s latest technical chart.

  • Current Price Action/Trends and Pivots: DAL’s decline from its November high is easy to see. The stock is a little less than 10% above its lowest point right now, but for the year remains slightly lower. Don’t be surprised this week to see the stock test that December low in the $45 price range; if news continues to be unfavorable, particularly if winter storms continue to cause delays in the Midwest or other parts of the country, the stock could drop below that point, and if that happens it might not find new support until the stock drops into the $36 to $37 range. Considering the bearish momentum that has been driving the stock for the past couple of months, it would be hard to argue for any kind of bullish rally until the stock breaks resistance above $50 per share.
  • Near-term Keys: The only kind of investment in DAL that I think makes any sense right now is a long-term one based on the stock’s fundamental strength and its value proposition; but I also think that the stock’s bearish momentum right should make even a value-driven investor wait to see if the stock’s current support level around $45 holds, or if it breaks down to establish new 52-week lows. If it does, an entry in the $36 to $37 price range certainly sound much more attractive. That kind of a bearish break could also an attractive opportunity for an aggressive, short-term momentum-based trade by shorting the stock or buying put options.