Delta is expecting to lose about $0.74 per share this year - that's the consensus of the twelve analysts who post annual earnings estimates. On gross annual revenues of over $20 billion, we think it's a sympton of the hyper-competitive airline market that this company expects post a loss of a roughly $250 million. Given the current environment of not only discount competitors, but also rising fuel costs, all the airlines are in the same boat. Delta has been boosting its fuel surcharges for passengers as fast as the other majors have, including last week's +$20 bump ($10 each way) that Northwest Airlines instituted. Sensitivity to energy prices in this industry is particularly evident in the stock charts we looked upon.
According to a Business Week article last week by Moira Herbst (May 7, 2008 issue of BW), Southwest Airlines is the only major airline to have instituted a hedging program in its fuel buying. Delta and the other carriers all have to contend with the same problem of soaring fuel costs, and there really isn't a solution to this problem for the carriers, other than passing the costs on to the consumer via fuel surcharges. Most of the other airlines, according this this article, don't have the cash available (effectively putting money "at risk") to hedge the billions of gallons of jet fuel that they need to buy. The premiums for the call options in the energy sector have gotten prohibitive.
Delta last came out with earnings in late April, in a combined statement with NWA, saying the losses amounted to over $10.5 billion. This was a combined result of huge write-downs on the companies' values, and losses due to fuel prices. Delta's losses specifically were $6.4 billion, despite a 12% rise in sales during the quarter. Excluding a special $6.1 billion non-cash charge relating to the drop in Delta's market value due to what the company referred to as "sustained record fuel prices", the airline lost $274 million in the first quarter of '08. Delta maintains that it would have recorded the special charge in the quarter regardless of its pending merger with NWA. Post-merger, both NWA and DAL intend to reduce costs through cutting flights, capacity and jobs. Obviously, the companies unions are both interested in preserving as many jobs as possible, and federal regulators are interested as well. With its capacity reductions, Delta said it expects to be profitable in the second quarter of '08.
Delta actually emerged from bankruptcy about a year ago, with a market value of around $12 billion. Since then, the stock price has been reduced enough so that its current market cap now stands at $2.2 billion. On the balance sheet, DAL maintains $8.80 per share in cash, a total of over $2.6 billion, but that is offset by $9.1 billion in debt. Operating free cash flow at the company is over $1.3 billion in the trailing twelve months, and the debt appears to be able to be covered at least on a current interest basis.
There is, as one might expect, a huge short position in DAL shares right now - some of that is no doubt due to merger arbitrage with NWA shares - but there is a 20 million share short position (about 7% of the float) in DAL right now. That is up from about 17 million shares short in April of 2008.
Although airline stocks have always been turbulent due to the tough nature of the industry, Delta stands to persevere in tough times because of its size even though smaller airlines may disappear. Also, tough times leads to industry consolidation, and gives Delta a chance to pick up regional airlines at bargain prices. In 2008, Delta merged with Northwest Airlines (NWA) for $2.6 billion, forming the world's largest airline by Available Seat Miles (ASMs).
Today, with the stock back to the $7.70 level, the options are also right back at $1.80, so we're issuing this note to say we still like this long stock / short call position very much - hold on here. Implied volatilities in the options on the airline stocks are in the triple digits.
On October 29,2008 Delta joined Northwest Airlines (NWA) to form the world's largest airline. Under the terms of the deal, NWA shareholders get 1.25 DAL shares for every one of their shares, so DAL will be the surviving entity.