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Morningstar | Delta Turns On Seat Belt Sign Amid Geopolitical Turbulence, but Our Long-Term Thesis Is Intact

Following fourth-quarter results and new guidance for 2019, we are lowering our fair value estimate for Delta Air Lines to $61 per share from $62. However, our long-term thesis is intact, and Delta remains the highest-quality airline among the North American carriers we cover with its investment-grade balance sheet, unique route structure, and persistent revenue premium. Our lowered fair value estimate rests on growing challenges for the global air travel market, like gridlock in Washington and geopolitical turmoil abroad. What’s more, we are skeptical that yield growth will remain robust amid a dramatic decline in oil prices. Nonetheless, we think no-moat Delta’s recent sell-offs were overdone and the market is beginning to offer an attractive risk/reward opportunity.

For the first quarter of 2019, management targets 5% consolidated revenue growth over the previous year. The lingering government shutdown, late Easter holiday, currency headwind, and weak trans-Atlantic market are expected to contribute to weaker top-line growth than during the same period in 2018. Notwithstanding first-quarter headwinds, we expect travel demand growth will remain challenged through the coming year, with Delta failing to reach the 3.5% year-over-year growth it posted in 2018. Consequently, we model total consolidated revenue growth around 5% over 2018, which is lower than 2018's 8% but at the midpoint of management’s guided range of 4%-6%. However, we expect soft oil prices and 2% year-over-year inflation for unit costs excluding fuel, profit sharing, and ancillary businesses will widen adjusted pretax margins about 30 basis points to 12.1% in 2019. We still model adjusted pretax margins expanding through our 2022 midcycle period to well over 13%.

Though we foresee softening global travel markets driving consolidated top-line growth below the 8% Delta posted in 2018, with weaker revenue per passenger mile growth or demand (2.9% in 2019 versus 3.5% in 2018) and yield growth (1.5% in 2019 versus 3.8% in 2018), we expect top-line tailwinds will come in the form of high-single-digit other revenue growth, namely double-digit loyalty program revenue growth derived from contractual cash contributions under Delta’s American Express partnership. We also model meaningful cargo revenue growth of 7% over 2018, but below the 16% and 11% recorded in the prior two years, signaling cargo spot rate deceleration will materialize much quicker than for passenger yields.

We believe management’s targets for 2019 remain achievable, and we’re encouraged by several developments like double-digit revenue growth in business and premium cabin products and Delta One cost-saving initiatives; however, we remain cautious of ongoing developments in the domestic and trans-Atlantic markets, given that these make up roughly 80% of Delta’s capacity or available seat miles. Domestically, CEO Ed Bastian estimates the current government shutdown will erase roughly $25 million in revenue every month the shutdown continues, due in part to the effect that Transportation Security Administration bottlenecks will have on future bookings, but also because Federal Aviation Administration inspector furloughs run the risk of delaying inspection and delivery of A220s and A330s, which are pivotal to Delta’s refleeting strategy. In trans-Atlantic markets, riots in France and Brexit in the United Kingdom are beginning to weigh on demand for international flights. Assuming these developments won’t remain contained to the first quarter, we lowered our full-year yield and demand forecasts for both markets. Finally, we assume Delta and its peers will look to reduce booking weakness and encourage travel growth with attractive fare offerings.