USD 39.16 B
P/E ratio 2017
The airline industry is characterised by its maximum operating leverage (the personnel is unionized, the licenses are expensive and the fleet is pricey in terms of maintenance), an activity that’s cyclical and highly capital intensive, and a killing competition: the sector could easily be mistaken for that of the semiconductors – of which we described the particularities in our recent analysis of STMicroelectronics.
The private airline companies – like the American ones, who operate on a different business model than State companies like Turkish Airlines or Qatar Airways – have multiplied their bankruptcies during the past decades and, on top of that, have never been able to redistribute their profits (when they did generate them) to their shareholders.
During the growth periods, the dividends were indeed fully consumed by the expansion of the fleet – and as the profits alone weren’t sufficient, the companies had to get themselves into a lot of debt to support their investment efforts.
During periods of recession, the combination of precarious financial positions and abyssal losses didn’t leave the unfortunate airline companies any chance: forced to refinance urgently, to liquidate or sell themselves for almost nothing, they ruined their shareholders as surely as one and one are two.
In France, the woes of Air France are illustrative of these difficulties.
However, just like the trends we observed at the manufacturers of semiconductors, the structure and competitive landscape of the civil air transport industry have radically evolved since the crisis of 2009.
Even Warren Buffett – an outspoken critic of the industry – changed his opinion while only a few years he ago he declared:
But that’s water under the bridge now, since Berkshire Hathaway announced in 2016 that it had taken major stakes in all four of the big American airlines: American ($42 billion turnover), Delta ($41 billion), United ($38 billion) and Southwest ($21 billion).
"The worst sort of business is one that grows rapidly, requires significant capital to engender the growth, and then earns little or no money. Think airlines. [...] Investors have poured their money into airlines for 100 years with terrible results. ... It's been a death trap for investors."
Indeed, the airline industry is largely ‘rationalized’ since the final series of bankruptcies. The smallest airline companies have disappeared while the regional companies have been bought, and the big companies – even better integrated into vast international networks (Star, Skyteam, OneWorld) – merged among each other: US Airways with American, Continental with United, Northwest bought by Delta etc.
As a consequence: being an oligopoly from now on, the different players aren’t forced to sacrifice their margins in order to gain market share anymore and each of them finds its place in this redesigned ecosystem.
Better yet, the big airline companies (the ‘majors’ of their industry) possess impregnable competitive advantages, because a newcomer – even when formidably capitalized – wouldn’t be able to reproduce their fleet, nor their domestic or international networks.
In short, the consolidation of the airline industry reminds us of that of the railway industry – an investment thesis that has worked well for Berkshire Hathaway since its acquisition of Burlington Santa Fe.
Known to be the best managed (next to Southwest) of the ‘big four’, Delta is the oldest, still active airline company in North America and the second one in terms of the number of passengers boarded (closely behind American).
With its long-term financial obligations ($18 billion) only just exceeding the company’s equity ($14 billion), Delta is also better capitalized than its two direct competitors (Continental and American).
Careful though: airline companies typically collect financial engagements outside their balance sheets, like purchase promises or maintenance contracts. At Delta, these kinds of agreements account for almost $5 billion between now and 2022 - mainly for leasing contracts and the purchase of new planes.
Just like its peers, Delta benefits from a kerosine price that has been decreasing since 2014 – a situation that suits the company because its fleet is older, but it’s a company tradition to keep its machines flying for the maximum of their lifespan.
The last three years, Delta has generated $7 billion of cash-flow per year (on average, because the year 2017 was penalized by a couple of adjustments in working capital need), while normally its investments reached $3,5 billion per year.
The normalized cash profit (free cash-flow) thus comes down to $3,5 billion on an annualized basis – and of course under similar macroeconomic circumstances.
From a market capitalization of $40 billion onwards ($56 per share), the company trades at more or less eleven times its profit – a very affordable valuation for a company that’s well-managed and of which the profit per share should increase over time, via the combined advantages of a recovering economy, the consolidation of the industry and share buybacks.
Delta Airlines thus enters the 4-Traders USA Portfolio.
Translated from the original article.
Article published on 03/14/2018 | 18:14