The Delta Airlines share has joined the MarketScreener USA portfolio
last March. Despite the increase of the oil price, it’s remarkable to see that the very good financial dynamics we observed back then still continue.
In our previous article, we painted a picture of the civil air transport industry in the United States, which is now completely ‘rationalized’ - meaning that nobody sells at a loss anymore to gain market share - because the entire market is concentrated in the hands of four big companies. In order of turnover size: American, Delta, United, and Southwest.
Oligopolistic situations are naturally very favorable for the margins of the market players; they benefit from this, conversely to an open competitive landscape without entry barriers, where aggressive new entrants don’t hesitate to sacrifice their profits to gain market share.
This industry rationalization lies by the way at the origin of Warren Buffett’s investment decision. Buffett is - in more or less equal proportions - a shareholder of the above mentioned four airline companies since four years. As Buffett describes it, what he observes in the air transport sector today is on every level comparable with what he observed at the time of his - very profitable - investment in Burlington Santa Fa in the railway sector.
While the share price of Delta has slightly declined since March (from $55 to $50), the company continues to show excellent fundamentals. Especially the increase of the fuel price - usually the main source of expenses after the salaries - has been well absorbed by an increase in business activity.
The turnover for the first half of the year grows (from $19.8 to $21.7 billion) while the operating profit decreases by only $500 million (from $3 to $2.5 billion) despite an extra billion dollars of fuel-related expenses. The operating margin goes thus from 15 to 11%, a performance that still exceeds the company’s historical average by a lot.
At a comparable level of activities, the operating profit should increase in the second half of the year, usually a happy period for airline companies thanks to the combined effect of holidays and increased ticket prices. This is why the management argues that the recapture of fuel-related costs takes between six and twelve months.
In parallel, we appreciate the strong financial discipline the management shows since the so-called ‘non-fuel’ expenses increase considerably slower (+0.2%) than the turnover (+9.6%) - proof of the very substantial operating leverage to which the activity is subject.
In terms of cash flow, the free-cash-flow reaches about $1.3 billion after tax and investments in assets, while this was still negative at te same time last year. The profit has entirely been paid back to the shareholders via $925 million of share buybacks - an excellent capital allocation as the price of the share remains undervalued - and $430 million of dividends.
At $50 per share, basing ourselves on our estimated normalized profitability of $3.5 billion per year - see our previous article
- and on a basis of 700 million shares in circulation - a number that decreases continuously thanks to the share buybacks - the company trades at 10 times its profit, a valuation that is surprisingly affordable for a big American capitalization with a future that is getting brighter.
The investors remain without a doubt skeptical towards an industry that is known to be tough - an industry that has accumulated hundreds of billions of losses these last decades - and they have perhaps not yet entered the paradigm change described by Warren Buffett in the books, providing the latter is right of course.
In any case, the valuations of airline companies remain very affordable. In particular, the capital allocation at Delta - buying back its shares at the top of the macrocycle when the shares trade at historically low levels - strikes us by its intelligence and its opportunism.
In the long term, this should be in the best interests of the company’s shareholders - both Berkshire Hathaway as well as the others.
Translated from the original article
Article published on 07/16/2018 | 10:19