Delta Air Lines (DAL -1.89%) has led the U.S. airline industry's post-pandemic recovery, returning to profitability in mid-2021 and moving steadily closer to pre-pandemic margin levels thereafter. Nevertheless, just three months ago, Delta stock sat well below where it traded in late 2020 -- when optimism about an air travel recovery was starting to take hold, but airlines were still losing billions of dollars every quarter.
Since then, Delta stock has surged more than 40%, thanks to moderating fuel prices and growing optimism about air travel demand. Even after this rally, the shares have substantial upside over the next couple of years, as the airline giant's earnings momentum continues to grow.
Guidance rising
In conjunction with its investor day on Tuesday, Delta Air Lines raised its guidance for the second quarter and the full year.
For Q2, the company now expects revenue to increase 17% to 18% year over year on a 17% capacity increase. Previously, it had called for 15% to 17% revenue growth. Meanwhile, fuel prices have declined significantly since Delta provided its initial quarterly guidance in early April. As a result, Delta projects that its operating margin will reach 16% this quarter, and the company raised its earnings per share (EPS) guidance by $0.25 to a new range of $2.25-$2.50.
Even that updated forecast looks conservative considering the recent decline in fuel prices. In fact, CEO Ed Bastian anticipates that Delta will post record Q2 EPS this quarter, beating the previous high-water mark of $2.35 set in 2019.
Delta is also growing more bullish about the second half of 2023. For the full year, it now expects EPS to reach $6, the high end of its previous guidance range. The company also raised its annual free-cash-flow outlook to $3 billion (compared to greater than $2 billion previously). That strong cash generation will allow it to reduce its debt quickly while also resuming its quarterly dividend.
Delta is just getting started
Looking ahead, Delta has numerous levers to drive profit growth beyond 2023. First, despite rising labor costs, the company expects non-fuel unit costs to decline next year as it moves back to pre-pandemic efficiency levels.
Second, the pace of fleet upgrades is set to accelerate next year. Delta has 133 jets on order for delivery in 2024 and 2025: enough to replace nearly 15% of its current mainline fleet. Delta's new jets typically produce margins at least 10 percentage points higher than those they replace.
Image source: Delta Air Lines.
Third, supply constraints for aircraft and labor could limit industry capacity growth for years to come. That will support continued unit revenue growth and margin expansion.
Fourth, Delta is making steady progress toward diversifying its revenue away from standard coach fares, which tend to be commoditized. Loyalty revenue is surging thanks to Delta's strong partnership with American Express. The carrier's new jets feature more extra-legroom and first-class seats, supporting rapid growth in premium revenue. Delta also expects to dramatically expand its engine maintenance division revenue from less than $1 billion in 2023 to over $5 billion annually by the 2030s.
For 2024, Delta expects EPS to surpass $7 and free cash flow to exceed $4 billion. And while profitability is likely to remain somewhat volatile due to the vagaries of the airline industry, the tailwinds highlighted above should drive strong earnings and cash-flow growth over the long term.
Delta stock remains extremely cheap
While Delta shares aren't quite as cheap as they were three months ago, the stock still trades for less than 8 times the company's updated 2023 earnings guidance and just 6.5 times its projected 2024 earnings. That looks like a great bargain, considering the company's potential to sustain and even grow its earnings beyond 2024.
Indeed, Delta's 2024 forecast implies earnings, free cash flow, and leverage roughly in line with 2019 levels. Delta stock traded around $60 for much of 2019, implying that the shares could rise another 30% within a year or so as investors gain more comfort with the airline's turnaround. That's why Delta Air Lines is one of the biggest holdings in my stock portfolio and is likely to stay there for a long time.
