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Morningstar | Delta Investors Reach for the Air Sickness Bag; Lowering FVE

Shares for domestic U.S. airlines traded sharply lower on fears of softening air travel demand and decelerating unit revenue growth following Delta’s investor update. We lowered our fair value estimate to $62 from $63, assuming yield growth will decelerate quicker than we initially anticipated in 2019, with oil prices finishing fiscal 2018 below our $60 Brent midcycle oil price. Our full-year total revenue per available seat mile, or TRASM, forecast for 2019 is now 17.14 cents, lower than the 17.20 cents we first expected. Nonetheless, we find today’s sell-off overdone and we don’t foresee dramatic changes to our longer-term assumptions or our no-moat rating for the carrier.

Management’s newly guided unit growth of 3%, below its earlier 4% midpoint projection, fueled investor concerns that carriers are failing to harvest savings from retreating oil prices. We find those concerns misplaced since Delta remains on pace to record pretax margin expansion of 100 to 200 basis points over the fourth quarter in 2017, corresponding to management’s 12% to 13% guidance, and in line with the 12% in our model.

We share investor concerns around looming weakness in air travel demand, and our updated model puts yield growth closer to 1.5%, behind the 1.8% we initially expected. Despite slower yield growth we still incorporate pretax margin expansion over 2018 and through our 2022 midcycle year as Delta’s oil costs hover around our midcycle price and nonfuel costs remain subdued.

We’re encouraged by the trajectory of CASM-ex, costs per available seat mile excluding fuel and other items. The carrier now plans to post a .5% CASM-ex decline over the fourth quarter last year and at the same time expects jet fuel prices will finish between $2.38 and $2.43, below the $2.47 to $2.52 range management issued earlier in the quarter. Taken together, management now guides adjusted earnings per share will finish at the top of its forecast range, between $1.25 and $1.30.

After lowering our TRASM expectations for 2018, adding Delta’s gain from its Global Services transaction, and adjusting for weaker oil costs during the fourth quarter, our pretax margin remains unchanged for the full year. Though we lowered our fair value on weaker yield growth in 2019, we maintain our longer-term assumptions that include easing air travel demand and oil reaching $60 through our midcycle period, pulling down passenger yields in the process.