Delta vs American Airlines: Investment Insights 2024

The airline sector is a dynamic and challenging industry, often influenced by external factors such as fuel prices, capacity management, and market sentiment. Let’s explore the detailed performance, challenges, and potential investment opportunities for Delta Air Lines (DAL) and American Airlines Group Inc. (AAL) with more explanations and statistical insights.

Delta Air Lines (DAL) Q2 2024 Performance

Financial Performance:

• Earnings Per Share (EPS): Delta reported an EPS of $2.36 for Q2 2024. Although this figure is impressive and close to record levels from the previous year, it fell short of market expectations, leading to a negative market reaction.
• Q3 EPS Guidance: Delta provided guidance for Q3 EPS in the range of $1.70 to $2.00, slightly below the analyst target of $2.06. This conservative guidance contributed to the market’s cautious sentiment.
• 2024 EPS Guidance: For the full year, Delta expects an EPS between $6 and $7, indicating strong profitability despite short-term challenges.
• Free Cash Flow (FCF): The company targets a free cash flow of $3 to $4 billion for 2024, highlighting its robust cash generation capabilities.

Revenue Composition:

• Total Revenue: Delta achieved a total revenue of $15.6 billion in Q2, driven by strong operational performance and demand.
• International Revenue Growth: Delta’s international revenue grew by 4%, reflecting a modest but steady increase in demand for international travel.
• Domestic Revenue Growth: Domestic revenues increased by 5%, indicating strong performance in the home market.
• Other Revenue (Loyalty Program): Revenue from the loyalty program surged by 19%, showcasing the value and growth potential of Delta’s customer loyalty initiatives.

Challenges:

• Fuel Costs: Delta faced a $300 million increase in fuel costs compared to Q2 2023, and fuel expenses were 25% higher than in Q2 2019. These rising costs put pressure on profitability.
• Capacity Issues: The airline experienced challenges in matching capacity with demand, particularly towards the end of Q2 and the beginning of Q3. This mismatch affected operational efficiency and revenue generation.

Strategic Initiatives:

• Dividend Increase: Delta increased its quarterly dividend by 50% to $0.15 per share, signaling confidence in its financial stability and commitment to returning value to shareholders.
• Unencumbered Asset Base: Delta expects its unencumbered asset base to reach $30 billion by the end of 2024. This growth in assets strengthens Delta’s balance sheet and provides flexibility for future investments and debt reduction.

American Airlines (AAL) Outlook

Current Stock Performance:

• Stock Price: American Airlines’ stock is trading around $10, reflecting significant market concerns over potential financial instability. This low valuation suggests that the market perceives a high risk of bankruptcy, despite the company’s operational performance.
• Q2 2024 EPS Guidance: American Airlines is targeting an EPS of $1.00 to $1.15 for Q2 2024, revised from an earlier guidance range of $1.15 to $1.45. This adjustment reflects the challenges faced in the current operating environment.
• Full-Year 2024 EPS Guidance: For the full year, the airline expects an EPS between $2.25 and $3.25, with consensus estimates slightly below $2. This guidance indicates a positive outlook despite short-term difficulties.

Industry Dynamics:

• Record Passenger Traffic: On July 7, the domestic airlines flew a record 3.01 million passengers, demonstrating strong demand for air travel post-pandemic.
• Airfare Trends: Average airfares have decreased by 9% year-over-year and are down 18% compared to 2019 levels. Despite this decline, fuel costs have increased, creating a challenging environment for airlines to maintain profitability.

Profitability and Valuation:

• Profitability: American Airlines remains profitable, even in the face of high fuel costs and capacity challenges. This profitability underscores the resilience of the airline’s business model.
• Stock Valuation: The current stock price of around $10 implies a substantial discount, suggesting that the market is overly pessimistic about the airline’s financial health. A $1 EPS for the year would justify the current stock price, while the consensus estimates of a $2 EPS indicate significant undervaluation.

Industry-Wide Context

Fuel Costs and Capacity Management:

• Fuel Costs: Fuel costs continue to be a major challenge for airlines. Airlines need to adjust airfares over time to offset higher fuel expenses. The current capacity imbalance has made this adjustment more difficult in the short term.
• Capacity Management: Legacy airlines, including Delta and American, are working to better align capacity with demand. Delta has indicated that capacity issues will improve significantly by August, leading to higher yields and better revenue performance.

Market Sentiment and Valuation:

• Investor Behavior: The airline stocks are often sold off on minor negative news, leading to undervaluation. This presents opportunities for investors to acquire stocks at a discount.
• Valuation Metrics: Delta trades at approximately 6x its EPS targets, highlighting its strong cash flow generation. Once Delta improves its debt ratings to investment grade, the company is likely to initiate share repurchases, further enhancing shareholder value.

Investment Thesis

Delta Air Lines:

• Strong Financial Position: Delta’s high EPS, robust free cash flow, and significant unencumbered assets position it well for future growth and stability.
• Future Prospects: The company expects improved unit revenue trends and better capacity management, leading to higher profitability and potential for share buybacks.

American Airlines:

• Undervalued Stock: American Airlines is trading at a price that suggests undue financial distress. The company’s profitability and potential for future stock buybacks make it an attractive investment.
• Profitability and Potential: With an expected EPS of around $2, the stock is exceptionally cheap. The improving balance sheet and operational performance suggest that the market’s fears of bankruptcy are overblown.

Key Takeaway

The current weakness in airline stocks, particularly American Airlines, presents a compelling buying opportunity. Despite market concerns, the fundamentals indicate strong profitability and improving financial health. Investors should consider accumulating undervalued airline stocks, anticipating positive developments in revenue trends and balance sheet improvements.