Should I take a different flight, Delta?

Expectations for Delta Airlines is very high at the moment trading at more than three times Fair Value. How can this happen?

There are several reasons why a stock trades at levels different than the Fair Value. One can be, the Fair Value is either overly optimistic or overly pessimistic; in other words, wrong. Another reason can be, at more than three times Fair Value, expectations in the market are much higher than what earnings have demonstrated; in other words the market could be wrong

What are the facts? Earnings did beat market estimates recently coming in at $0.78 versus an estimate of $0.75 but, this is hardly a level that generates a 3X Fair Value position. Looking at the last two price moves you see a drop in price but, why would the price drop if earnings are a positive surprise? Maybe the market is getting concerned?

We need to look back further than just the most recent quarter and see how earnings have performed. If we go back to when Delta purchased the refinery, earnings were about $0.32/share. They ranged from ($0.38) to $0.91. The refinery cost over $400 million in acquisition and renovations. Remember, these were renovations the previous owner thought uneconomical. In 2012, the refinery contributed a $63 mn loss and in 2013 added another $116 mn loss. If the refinery was going to pay off, it had better start producing economic benefit soon.

Since the refinery purchase, earnings have reached a high of $1.41, but have only been able to average $0.80. While this is an improvement, it is not that much higher than pre-refinery purchase. With oil now at a $50/bbl level, the strategic advantage of Delta’s purchase should be in question. Additionally, concerns over continued capital improvements in a refinery the previous owner thought was uneconomical are concerning. The previous owner was experienced in refining crude based products; Delta has no experience and is sometimes questioned as to their skill in managing an airline. (Just ask the retired Delta pilots of ten years ago who watched their pension plan decimated in the bankruptcy process.)

Airlines are romantic and exciting because they fly people to exciting places around the world. However, it is an expensive activity with little margin for error. Just think of the names that no longer fly under an independent badge: PanAm, TWA, Piedmont, Northwest Orient, National, Ozark, Northeast and the list goes on and on. It is not a business for the faint of heart nor should it be for the investor that is not willing to watch dramatic climbs followed frequently by a sudden crash.

At the current level you might consider taking a different flight.

For an interactive chart select: https://www.tradingview.com/x/3UQw9KhR/

By | 2015-02-13T08:06:29+00:00 February 13th, 2015|Categories: Money Basics|Tags: , |0 Comments

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