Domestic Cabin Demand And Tariffs Will Pressure Operating Margins

Key Takeaways

• Economic uncertainties and travel demand decrease could stagnate revenues, especially if corporate budgets shrink during tough conditions.
  
• Rising non-fuel costs and potential tariff impacts on aircraft could hurt profitability, limiting Delta's growth if expenses persist outpacing revenue.
  
• Delta Air Lines demonstrates robust revenue growth and profitability through diversified streams, resilient premium and loyalty income, and effective cost management amidst economic uncertainties.

Catalysts

Provides scheduled air transportation for passengers and cargo in the United States and internationally.

• Delta is experiencing a slowdown in domestic demand, particularly in the main cabin, amidst a challenging macro environment. This could lead to lower revenues than expected if consumer and corporate travel do not recover as anticipated.
  
• The company is planning to keep capacity growth flat in the second half and reduce domestic main cabin seats, which may further compress operating margins if demand remains weak and Delta cannot proportionately reduce costs.
  
• Given the extensive economic uncertainty, there is potential for continued pressure on corporate travel volume, leading to stagnation or declines in revenue. This could intensify if companies reduce travel budgets during periods of prolonged economic challenges.
  
• Delta is facing increasing non-fuel unit costs, which grew by 2.6% over the previous year. If costs continue to rise without adequate revenue growth, it could compress net margins and reduce overall profitability.
  
• The potential negative impact of tariffs on aircraft acquisitions, alongside planned capacity reductions and accelerated aircraft retirements, could imply substantial capital expenditure adjustments. This might hinder earnings growth projections if new plane acquisitions are delayed or result in increased costs due to imposed tariffs.

Delta Air Lines Future Earnings and Revenue Growth

Assumptions

• This narrative explores a more pessimistic perspective on Delta Air Lines compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts.
• The bearish analysts are assuming Delta Air Lines's revenue will decrease by 1.3% annually over the next 3 years.
• The bearish analysts assume that profit margins will shrink from 5.9% today to 5.6% in 3 years time.
• The bearish analysts expect earnings to reach $3.3 billion (and earnings per share of $5.31) by about May 2028, down from $3.7 billion today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 9.3x on those 2028 earnings, up from 8.1x today. This future PE is lower than the current PE for the US Airlines industry at 10.5x.
• Analysts expect the number of shares outstanding to grow by 1.17% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 8.38%, as per the Simply Wall St company report.

Delta Air Lines Future Earnings Per Share Growth

Risks

• Delta Air Lines has achieved a record revenue for the March quarter and delivered solid profitability, indicating strong revenue streams and the potential for stable earnings.
  
• Despite economic uncertainties, the company continues to show resilience in premium and loyalty revenue, supporting overall revenue stability and potentially maintaining or increasing profit margins.
  
• The airline's diversified revenue streams, including American Express remuneration growing by 13%, contribute to steady earnings and provide a buffer against volatility in consumer and corporate travel.
  
• Delta's focus on cost management, including flat capacity growth plans and efficient cost controls, aims to protect operating margins and ensure strong net margins and free cash flow.
  
• International and premium segments remain strong, currently insulated from domestic demand softness, which supports sustained revenue growth and stable net margins.

Valuation

• The assumed bearish price target for Delta Air Lines is $36.0, which represents the lowest price target estimate amongst analysts. This valuation is based on what can be assumed as the expectations of Delta Air Lines's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $88.0, and the most bearish reporting a price target of just $36.0.
• In order for you to agree with the bearish analysts, you'd need to believe that by 2028, revenues will be $59.6 billion, earnings will come to $3.3 billion, and it would be trading on a PE ratio of 9.3x, assuming you use a discount rate of 8.4%.
• Given the current share price of $45.3, the bearish analyst price target of $36.0 is 25.8% lower.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.