With fuel prices moderating compared to 2022 and travel demand remaining quite strong, 2023 is shaping up to be a great year for U.S. airlines. Airline stocks have responded, particularly shares of the three biggest carriers that dominate the industry.
Delta Air Lines (DAL -1.89%) stock has already risen 42% since the beginning of 2023 as investors have grown more optimistic. With shares having pulled back in the past few days despite a massive earnings beat, this could be a great time to buy Delta stock.
A huge earnings beat
Three weeks ago, Delta raised its earnings forecast at an investor event. The company boosted its Q2 adjusted EPS guidance by $0.25, to a new range of $2.25 to $2.50.
Despite the guidance increase, Delta's outlook still looked conservative at the time. Sure enough, the airline reported that adjusted EPS reached $2.68 last quarter: up 86% year over year. Unit revenue inched up just 1%, but with fuel costs down by 34% per gallon compared to 2022, Delta's adjusted operating margin expanded to 17.1% from 11.7% a year earlier.
With the business continuing to fire on all cylinders, Delta raised its full-year outlook again last week. Management now expects full-year adjusted EPS to come in between $6 and $7. Late last month, the company had raised its adjusted EPS forecast to $6 from a prior range of $5-$6.
Importantly, while the June CPI report highlighted a significant decline in airfares -- rattling some investors' nerves -- Delta executives see no signs of demand slowing. Booking trends remain strong and corporate surveys show that, if anything, business travel is likely to accelerate later this year.
A cash machine
Through the first half of 2023, Delta has generated $2.95 billion of free cash flow, adjusted for a one-time pilot bonus payment and a handful of smaller items. Thus, the company has already essentially met its full-year free cash flow target of $3 billion.
While airlines' cash flow tends to be weighted toward the first half of the year, Delta still has a good chance of beating its full-year guidance. That would allow it to pay down even more debt than planned in 2023. Strong cash flow is also enabling Delta to restart its dividend this quarter.
Image source: Delta Air Lines.
Importantly, Delta is generating this free cash flow while also reinvesting billions of dollars into the business. The airline has over 300 aircraft on order: enough to replace a third of its mainline fleet. Most of these jets are set to arrive within the next four years. The upcoming wave of fleet upgrades will significantly improve fuel efficiency, reduce maintenance costs, and make more efficient use of pricey pilot labor, supporting long-term profit growth.
A gift from the market
Despite the big earnings beat and guidance increase, Delta stock actually retreated slightly on Thursday and fell further on Friday. Based on the midpoint of the company's updated full-year forecast, the stock still trades for just seven times earnings. That makes Delta Air Lines stock an incredible bargain for long-term investors even after its big rally this year.
Thanks to its rising earnings and strong cash flow, the company has already made significant progress toward repairing its balance sheet. Management expects Delta's credit metrics to improve to investment-grade levels by the end of 2024. That would reduce the inherent risk of holding Delta shares, while allowing the company to start returning more cash to shareholders.
Meanwhile, adjusted EPS is likely to keep growing well beyond $7 over the next several years as Delta focuses on reducing unit costs while driving growth in non-ticket revenue. That puts Delta stock in good position to continue beating the market for years to come.
