United Airlines and Delta Air Lines stock deserves a rerating.
There’s much more to Delta Air Lines (DAL -1.19%) and United Airlines (UAL 0.17%) than relying on mass consumer discretionary spending in the travel sector. These two airline stocks all have significant megatrends behind them, which could lead to long-term growth and a valuation rerating. Here’s why both stocks are attractive stocks to buy.
Outperforming stocks in 2024
United Airlines and Delta shares are up strongly in 2024, but both stocks have room to run. Despite the run-ups in the stocks, they trade on 7.1 times and 9.2 times Wall Street analyst earnings expectations for 2024.
DAL data by YCharts.
The low earnings valuations are due to their high debt, and the market worries about their earnings’ traditional cyclicality. Delta ended the third quarter with $18.7 billion in adjusted net debt.
But here’s the thing: Delta has already generated $2.7 billion in free cash flow (FCF) in 2024, and Wall Street analysts expect about $3.4 billion for the full year. Management expects to repay $4 billion in debt in 2024, which is part of the reason why Moody’s and Fitch have now rated its debt as investment grade.
Image source: Getty Images.
This time, it’s different
Moreover, recent events challenge traditional assumptions about the industry’s highly cyclical nature. Historically, the industry’s return on investment hasn’t covered its cost of capital , with airlines often electing to continue running unprofitable routes as they wait for an upturn, fuel prices to drop, or some other catalyst to improve earnings.
However, both United and Delta have recently reported that the overcapacity in the industry over the summer resulted in North American airlines reducing capacity where necessary. For example, Delta’s president Glen Hauenstein noted, “Domestic industry seat growth moderated significantly from the peak in June, with the industry now growing seats in line with demand” on the recent earnings call.
United Airlines CEO Scott Kirby was even more explicit in his company’s earnings call: “We’re seeing unprofitable capacity to begin to exit the market, leading to the expected domestic yield improvement.”
Underlying growth is better than the headline numbers suggest
On a headline basis, both airlines reported rising cost per available seat mile (CASM) and declining revenue per available seat mile (RASM) — usually a worrying sign.
|
Third Quarter Year Over Year Growth |
Non-Fuel Cost per Available Seat Mile |
Revenue per Available Seat Mile |
|---|---|---|
|
Delta Air Lines |
5.7% |
(1.1)% |
|
United Airlines |
6.5% |
(1.6)% |
Data source: Company presentations.
However, CASM and RASM were negatively impacted by the CrowdStrike update issue and suspension of routes to the Middle East. Moreover, both metrics are set to improve for Delta and United in the near future.
Delta’s Hauenstein noted “unit revenue inflected to positive in both domestic and transatlantic” in September,and management’s fourth quarter guidance calls for non-fuel CASM growth to moderate to 3%.
Meanwhile, at United “Domestic PRASM was slightly positive in August and September year-over-year, which was a material improvement from earlier in the quarter where it was down 4%.” For reference, PRASM is passenger RASM. As for non-fuel CASM, United expects pressure from labor agreements to be offset by “tailwinds from better utilization and firmer capacity plans” in 2025 according to CFO Mike Leskinen.
More than just main cabin revenue
In addition, Delta’s focus on premium customers is bearing fruit. Even though the third quarter was hit by the CrowdStrike update issue, which canceled and delayed flights, Delta’s revenue from premium products grew 4% compared to a 5% decline in main cabin revenue. Furthermore, Delta’s revenue from its loyalty program grew by 7%, and Delta and United continue to grow revenue from their co-branded credit cards.
Image source: Getty Images.
For example, Delta’s remuneration from American Express grew 6% to $1.8 billion in the third quarter year over year. Indeed, Delta generated 57% of its revenue outside its main cabin products in the first three quarters of 2024.
An improving end-market environment
With a lower-interest rate environment likely in 2025, consumer discretionary spending on travel should improve, and higher-margin corporate travel continues to improve. Both Delta and United are improving their balance sheets by improving FCF and lowering debt. Meanwhile, the loyalty programs and co-branded credit cards continue to provide a relatively stable and diversified revenue stream.
Moreover, the behavior change is reflected in the outlook for profitability at both airlines. The International Air Transport Association (IATA) estimates the worldwide airline industry will earn $30.5 billion in net profits, with North America responsible for $14.8 billion of it with a net profit margin of 4.5%.
This is comparable to Wall Street estimates for Delta to generate $3.9 billion in net income with a 6.4% margin and United Airlines to generate with $3.2 billion in net income with a 5.6% margin.
Image source: Getty Images.
Clearly, both airlines are generating profitability above the industry average. On the downside, their earnings will still be cyclical. After all, travel demand does ebb and flow with the economy, and it is an industry with relatively high fixed costs and exposure to fuel prices. In addition, Delta and United still have high levels of debt.
That said, there’s a strong case for the argument that they are not quite as cyclical as the market is now pricing into their valuations. Moreover, suppose the North American airline is entering an era of rational behavior (as indicated in the behavior over the summer) in quickly responding to reduce capacity where necessary. In that case, both stocks deserve a valuation rerating from the kind of high-single-digit price-to-earnings ratios they trade on now.