The case for buying stock in Delta Air Lines (DAL 9.83%) isn't just based on its exposure to the ongoing recovery of the travel industry. It's also about Delta's focus on the premium travel market and its burgeoning credit card remuneration and loyalty program. The good news is that there's hard evidence of a return to solid growth in premium traffic, which is a significant plus for Delta's growth plans.
Delta's premium focus
Delta investors already know that its premium (business and first class) revenue is growing at an impressive rate. Delta's premium product ticket revenue grew 10% in the first quarter, compared to a 4% increase in its main cabin ticket revenue. Not only do premium travelers generate more revenue per passenger-kilometer, they generate higher margins than main cabin travelers.
The increase in premium revenue is part of a trend. Delta's premium revenue of $19 billion in 2023 represented 35% of its total revenue, compared to $10 billion in 2014, which represented 24% of total revenue. Moreover, it isn't just about growing premium cabin revenue per se, because attracting and maintaining premium customers is a significant benefit to the growth of its SkyMiles loyalty program and its co-brand American Express credit cards.
Management aims to grow its premium revenue to 37% of sales over the long term, with loyalty/other contributing 23% and the main cabin 40%. This represents a significant shift from 2014, when the main cabin contributed 56% and loyalty/other just 20%.
Delta will get there by attracting premium travelers. This will help grow American Express' remuneration to Delta through the use of co-brand credit cards, which now account for about 1% of the U.S. gross domestic product.
Image source: Getty Images.
The importance of the premium traveler to Delta's loyalty revenue was highlighted in the first quarter, when "loyalty revenue grew 12% on continued strength in the American Express co-brand portfolio with record quarterly remuneration of $1.7 billion" and "we saw card applications reach new records as we are seeing the highest premium acquisition mix in our program's history," according to company president Glen Hauenstein on the earnings call.
Here's the good news
The International Air Transport Association (IATA) publishes data on the airline industry, and its latest data outlining how premium traffic and revenue are back on track makes a happy reading for Delta investors because it confirms that the return of business and premium travelers is an industrywide event.
Indeed, the IATA notes that airlines across all regions saw increased premium revenue year over year in the first quarter "for an essentially unchanged level of capacity allocation to this segment."
As such, North American carriers (including Delta) increased the share of revenue from premium cabins by 9.4 percentage points (ppt), compared to just 1 ppt increase in the share of revenue passenger kilometers (RPK) coming from premium cabins.
This industrywide phenomenon sets Delta up nicely for a strong summer traveling season.
Delta's medium-term aims
Delta management is forecasting earnings per share (EPS) of $6 to $7 in 2024, with free cash flow (FCF) of $3 billion to $4 billion. I think Delta's stock is undervalued on that basis; it currently trades at slightly less than 8 times the midpoint of management's earnings guidance and less than 10 times the midpoint of its FCF guidance.
The earnings and free cash flow are designated to help Delta reduce the debt burden accumulated during the pandemic's height. Management aims to reduce its adjusted debt to earnings before interest, taxation, depreciation, amortization, and rent (EBITDAR) to a range of 2 to 3 times EBITDAR.
Image source: Getty Images.
Those types of debt-to-earnings multiples will encourage rating agencies to classify Delta's debt as investment grade. That will help strengthen the stock's investment case, as will an affirmation that its focus on the premium traveler will bear fruit in 2024. If the IATA data is accurate, Delta will have a good chance of achieving its aims in 2024.
