Can Delta Avoid Turbulence in 2013?

Less than ten years ago, four of the seven major airlines in the U.S. filed for Chapter 11 bankruptcy protection. The airline industry has proved an erratic environment for investors ever since; however, with Delta Air Lines Inc. (NYSE:DAL) up almost 130 percent since September, is it time to take a serious look at airline stocks again? Let’s use our Cheat Sheet investing framework to decide whether Delta is an OUTPERFORM, WAIT AND SEE, or STAY AWAY.

C = Catalysts for the Stock’s Movement

A major reason for the success of Delta and its peers over the past several years is the re-consolidation of the airline business. Four significant mergers since 2008 are helping return stability to the industry. Capacity has decreased and airlines have gotten some pricing power back. One such merger was Delta and Virgin Atlantic.

Delta acquired a 49 percent stake in Richard Branson’s airline from Singapore Airlines last December. This merger will give Delta increased market share at London’s Heathrow Airport, one of the world’s busiest airports.

E = Earnings Growth is Mixed

Delta’s year-over-year earnings growth pattern is extremely erratic. While Delta generated a 1.03 percent revenue increase and free cash flow of $457 million during the first quarter this year, earnings per share fell nearly 100 percent from the first quarter in 2012. The decline was mostly due to increased salary expenses and investment in operations; as a result, operating margins fell by 60 basis points. Revenue growth at the airline paints a much prettier picture and is steadily increasing each quarter. This attractive pattern in revenue growth can be attributed to increased yields from domestic flights, but the sporadic earnings growth is a huge red flag, especially for risk-averse investors.

S = Support Is Provided by Institutional Investors but Not Company Insiders 

Delta has been getting a lot of love from “smart money” as of late. Sixty-eight hedge funds currently hold Delta in their portfolio — up 10 percent from the previous quarter. Lansdowne Partners, managed by Paul Ruddock and Steve Heinz, has $576.9 million invested in Delta. Wayzata Investment Partners owns the second highest amount of Delta, with a long position of $565.4 million. Unfortunately, insiders have not been as enthusiastic about the stock — execs have sold around a quarter of a million shares in the past two months.

T = Technicals Are Strong

Delta closed at a price of $19.36 on Monday, above both its 200-day moving average of $15.70 and its 50-day moving average of $18.38. The airline is experiencing a strong uptrend since December. The stock has been on a tear since September – up almost 130 percent since it posted its 52-week low of $8.42 on September 4. The stock posted a fresh 52-week high on Monday of $19.73.

Conclusion

Delta impressed analysts with its first-quarter earnings figures, and the airline industry appears to be operating with some semblance of stability recently. Delta, however, has been unable to show that it can generate steady earnings per share growth due to the high variability of its operating expenses. The erratic increases in operating expenses are partially a result of the volatile industry and partially a result of Delta’s management team. For example, Delta recently acquired a refinery in Trainer, Pennsylvania, last May. The refinery is supposed to save $300 million in fuel costs but has posted losses in two straight quarters. Despite some poor managerial decisions, the outlook of the airline industry looks better compared to the last few years. Investors should WAIT AND SEE if Delta can post steady earnings numbers and profit margins in the next quarter before deciding to initiate a long position.

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