Delta vs. Southwest: Which Airline Can Get Out of Sell Zone?

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Delta Air Lines DAL and Southwest Airlines Co. LUV – with their market capitalizations of $28.09 billion and $22.86 billion, respectively – are two well- known players in the US airline industry.  However, both these well-established stocks are currently under pressure as is displayed by their Zacks Rank # 5 (Strong Sell).

The tough times are not limited to these two carriers only. The entire airline industry is reeling under an array of headwinds which include the surge in terror attacks, uncertainty following the Brexit vote, unit revenue issues and technological glitches. Additionally declining airfares have the potential to hurt the top line of airline companies, affecting profits. The Zacks Industry rank of 241 (among 260+ groups) carried by the Transportation-Airline segment is indicative of the tough times that the stocks in this space are going through.

Q2 Outperformances Fail to Lift Stock Prices

The second-quarter 2016 earnings season did see quite a few airline companies reporting better-than-expected earnings or revenues or both. But the outperformance has done little to bolster the stock prices in most cases. For example, the Delta, which beat on earnings but missed the top line, has shed over 9% ever since its earnings release on Jul 14. Southwest Airlines, on the other hand, missed on earnings but topped on revenues in second quarter. The Dallas-based low-cost carrier has also seen its stock price decline since its earnings release on Jul 21 despite outperforming on the revenue front.

In fact these two well-established names have been struggling for quite a few months due to the above mentioned headwinds and second quarter outperformance (bottom-line for Delta and top line for Southwest) have failed to entice investors. The toiling of these well-established carriers are indicative by the fact that the Delta stock has lost 26.87% year-to-date while Southwest Airlines has seen a double-digit slump in its stock price since the commencement of 2016. Moreover, earnings estimates have also moved south for these carriers further highlighting that these two stocks are not favored by analysts at present.

In case of Delta, 2016 Zacks Consensus Estimate fell in excess of 8% over the last 60 days to $5.79 per share.  The 2016 Zacks Consensus Estimate has declined almost 5% over the last 30 days to $3.87 per share for Southwest.

Let’s take a look at some of the major headwinds plaguing these two well-known carriers which have affected their stock price.

Unit Revenue

Delta and Southwest like their peers have been plagued by unit revenue issues for quite some time.  Passenger revenue per available seat mile (PRASM: a key measure of unit revenue) declined at both these carriers in the second quarter. Moreover, PRASM fell 7% in July at Delta impacting the stock. The sharp drop was due to foreign exchange woes along with the ongoing supply-demand imbalance in the Transatlantic and softness pertaining to domestic yield.

Southwest Airlines too was impacted when it gave a bearish guidance with respect to operating revenue per available seat mile (RASM) for the third quarter. RASM is now anticipated to decline in the range of 3.5% to 4.5% as compared to the earlier projected range of 3.0% to 4.0%.

Disruptions

Both these stocks were in the news recently owing to disruptions in their operations causing undue harassments to its passengers.  On Jul 20, Southwest Airlines had to cancel 400 flights, and delay nearly 2,000 due to a computer glitch. Operations at the Atlanta, GA- based Delta were similarly disrupted due to a power outage in Atlanta on Aug 8 which affected the computer systems resulting in disruption of the company’s operations worldwide.

Delta’s Chief Operating Officer issued a statement apologizing for the delay. The company also issued a $200 travel voucher to customers whose flights were delayed by over three hours or had been cancelled altogether.

Surge in Terror Attacks & Brexit

The increase in terror attacks is a looming threat to airline stocks with Delta and Southwest being no exceptions to this threat. This is because such attacks give rise to the possibility of air travel demand slackening on account of security fears. Furthermore, uncertainty following the Brexit vote in late June has also hurt the stocks due to declining demand for Business travel. With respect to exposure to Britain, Delta is very much at risk as it has a significant stake in British airline –Virgin Atlantic. To counter the threat, the carrier has decided to trim 6 points of the U.S. – U.K. capacity from its winter schedule.

While it is true that the above-mentioned headwinds have caused the two stocks to fall out of favor of late as far as investors are concerned all is not lost for these carriers. As with their impressive fundamentals they will be looking to turnaround things. Let’s take a look at the favorable factors.

Oil still Below $50

Fuel costs represent one of the major expenses for airlines. Unsurprisingly, weak oil prices are a boon to airlines. Oil is currently hovering around the $45 a barrel mark. While this represents a strong resurgence from the 12-yeqar low of around $26 a barrel hit in February, the fact remains that the commodity is still trading at levels much lower than those ($100+ a barrel) witnessed in mid-2014. It is also true that since oil has been cheap for almost 2 years, this major tailwind has already been priced in and is not as big a growth driver now as it was a few quarters back.

Having said that, it remains a fact that this major input cost for airlines is still low. For example, second quarter earnings at both Delta and Southwest expanded in double-digits on a year-over-year basis on the back of cheap oil. With oil unlikely to touch the mid-2014 highs any time soon, soft oil prices should continue to benefit carriers including Delta and Southwest going forward.

Dividend  

Cheap oil has resulted in huge savings for carriers, improving their financial health. This has caused most carriers including Delta and Southwest to shell out and hike their dividend payouts. In May 2016, Delta hiked its quarterly dividend payout by 50% to over 20 cents a share. Also in May, Southwest hiked its quarterly dividend by 33.33% to 10 cents a share. Both companies, apart from having a good dividend paying history, are also rewarding its shareholders through buybacks.

It is a no-brainer that investors are extremely attracted by high yielding stocks in terms of dividend and here Delta scores over Southwest as its annual dividend yield of 2.2% is much better than Southwest’s comparable figure of 1.09%.

Delta’s Record Profit Sharing

Earlier this year, Delta’s employees received the highest payout in the history of corporate profit sharing programs. The total payout of $1.5 billion meant that employees received more than 21% of their 2015 annual earnings. The comparable figure was 16% in 2014. On the other hand, Southwest’s profit sharing payment was $620 million which equates to approximately 15.6% of each employee’s earnings in 2015. Even though Southwest’s payment was also the highest in the low-cost carrier’s history, it came nowhere close to Delta’s payout. We anticipate Delta to trump Southwest with respect to profit sharing in future too owing to its strong balance sheet. 

Delta’s Debt Reduction Impresses

At the end of the second-quarter 2016, Delta had $1.66 billion in cash and cash equivalents and adjusted net debt of $6.78 billion. The company has managed to reduce its net debt  significantly from 2009 levels. Delta generated free cash flow of $1.6 billion and adjusted operating cash flow of $2.6 billion in the second-quarter 2016.

Other Metrics

Despite the woes, Delta’s earnings per share in the current year are projected to grow at 25.5% which is much higher than Southwest’s projected bottom-line growth of 9.8% for 2016. Delta’s earnings growth rate (3-5 years) is 11.07% which again compares favorably to Southwest’s 9.83%.

In terms of forward price-to-earnings ratio (P/E) too, Delta wins the contest as it is cheaper than Southwest. The valuation metric for the current year at Delta is 6.41, which is much lower than Southwest’s 9.53. Moreover Delta’s PEG ratio of 0.59 is lower than Southwest’s 0.97. Also in terms of VGM Score  Delta scores over Southwest. Here V stands for Value, G for Growth and M for Momentum and the score is a weighted combination of these three scores. Delta’s VGM score is ‘A’ compared to ‘B’ for Southwest.

Finally, Delta’s larger business size compared to Southwest gives it the gargantuan scale to stand up a bit better to industry headwinds.

The above parameters suggest that Delta will come out of the present mess faster than Southwest.
 

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