Can Delta Airlines Take Investors' Returns To New Heights?

In the third quarter of fiscal year 2013, Delta Airlines' (DAL) available seat miles, or ASM, increased 2.6% year over year to 63.9 billion. ASM is a measure of an airline's capacity of carrying passengers. To increase its ASM, the company ordered 40 EADS' Airbus jets for around $6 billion. These jets are meant for both domestic and international passengers, and the delivery is expected to commence in 2015. Currently Delta Airlines' fleet comprises of around 158 Airbus jets. This order for new jets will increase this tally by 25% to 198 Airbus jets.

Delta Airlines will further increase its passenger revenue with its deal with Virgin Atlantic Airways. It acquired 49% stake in Virgin Atlantic Airways for $360 million. It received the final clearance of this acquisition from the U.S. Department of Transportation on September 23, 2013. As per this acquisition, Delta Airways will increase its service offerings by adding flights for the New York to London route.

From March 30, 2014, together, both companies will operate around 32 daily non-stop flights between North America and the U.K., including seven daily non-stop flights between New York and London's Heathrow International Airport. Heathrow reported growth of 4.6% year over year to around 6.3 million passengers in October 2013. With this significant growth rate, I believe Delta Airlines is well positioned to gain on the increasing number of passengers, owing to the increase in the number of flights from this international airport.

Prior to this acquisition, Delta Airlines had merely 9% of the market share on the lucrative route linking New York with Heathrow. After acquiring the stake in Virgin Atlantic, Delta Airlines' market share would increase to 36%, which is next to the British Airways and American Airline's alliance. The alliance of British Airways and American Airlines occupies around 50% of the market share. Furthermore, Delta Airlines' market share increase will also pose challenge to its nearest rival, United Continental (UAL), which holds market share of around 13% on this route.

Besides this, Delta Airlines also plans to increase its passengers' revenue from the international passengers. To gain traction with international passengers', Delta Airlines is expected to start providing in flight Wi-Fi services on international flights by the end of this year. In the third quarter of fiscal year 2013, Delta Airlines' passenger revenue grew 6.7% year over year. I expect that with the above discussed factors regarding the Airbus order, acquisition of stake, and inflight Wi-Fi services, this growth rate of passenger revenue will further increase next year.

Peer's growth plan

Though United Continental faces headwinds from Delta Airlines at Heathrow International Airport, its wholly owned subsidiary, United Airlines, expects growth at Chicago's international airport. Chicago's O'Hare International Airport is the second busiest airport in the U.S. Moreover, United Airlines is the largest carrier at O'Hare, carrying more than 45% of the airport's total passengers. To boost its revenue from this important airport, United Airlines began nonstop flights from O'Hare International Airport to Luis Munoz Marín International Airport in San Juan, Puerto Rico on November 5. This service is expected to operate using Boeing's (BA) 737-900. To further gain from O'Hare, United Airlines will begin new nonstop flights from Chicago's O'Hare International Airport and Houston's George Bush Intercontinental Airport to Atlantic City next year.

These new flights are important for the company because Chicago and Houston are United Airlines' largest hub airports. According to the International Civil Aviation Organization, or ICAO, report of October 2013, Chicago's O'Hare was the largest international airport, in terms of departure, with year-over-year growth of 1.2% to 3.15 million passengers. With the above discussed growth prospects regarding O'Hare, I expect United Airlines will benefit from the growth rate of this airport, as it is the largest passenger carrier airline at O'Hare International Airport. In the third quarter of fiscal year 2013, the company's passenger revenue increased 1.6% year over year. I expect that with the above discussed growth factors, this growth rate will continue to increase next year.

Stock Valuation

Delta Airlines competes with US Airways (LCC) in the "major airlines' industry. The trailing twelve months price to earnings, or PE, ratio of Delta Airlines is 11.5, lower than the industry's PE ratio of 32.50. This trailing PE ratio is higher than Delta Airlines' forward PE ratio of 8.86. US Airways' trailing 12 months PE ratio is 8.24 and forward PE ratio is 7.08. Since the difference between the two PE ratios is more prominent in Delta Airlines, this implies that Delta Airlines' earnings are expected to rise more than those of US Airways going forward.

The price to free cash flow, or P/FCF, of Delta Airlines is 19.26, lower than the industry's P/FCF of 27.84. Delta Airlines' price earnings growth, or PEG, ratio is 0.53, also lower than the industry's PEG ratio of 0.88. All these valuation parameters indicate that Delta Airlines' stock is currently undervalued. Although I prefer Delta Airlines over US Airways on the basis of valuation, I am bullish on the growth fundamentals of US Airways too. It expects to boost its passengers' revenue from Charlotte Douglas Airport under its international expansion plan. I discussed the financial impact of this international expansion plan in my previous article on US Airways.

Conclusion

Delta Airlines expects to grow fundamentally with its acquisition of 49% stake in Virgin Atlantic Airways. With this acquisition it poses strong competition for its rival, United Continental. The growth prospects of Delta Airlines are well supported by its stock valuation parameters. Going forward, I expect Delta Airlines' earnings will grow and advise investors to consider this company as a safe bet for their portfolio.

Source: Can Delta Airlines Take Investors' Returns To New Heights?

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. (More...)

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