DAL: Delta Looks Better When You Don’t Look Too Closely
This article was originally published at RealMoney on September 17, 2007.
When I saw out-of-the-money calls Delta Airlines (DAL) on StockPickr’s stocks with heavy option volume my first thought was that it must have been one of the short squeeze airline plays also mentioned on StockPickr. Nope. So that got me thinking. I typically don’t want to touch airlines with a 10-foot pole, but they do make for the occasional good trade. Is this one of those occasions?
For me, even a speculative trade has to have something underneath it for support. At first glance, it looks like Delta has that. 2008 EPS estimates are at $1.80 and have been marching up steadily, now giving the company a single-digit P/E multiple. Price/Book is also low, but only because they exited bankruptcy with a load of goodwill on the balance sheet. Excluding that, the book value is negative. They have a fair amount of cash, but plenty of near-term liabilities on which to spend it. All in, their total net debt is more than $5 billion, resulting in an enterprise value of $9.7 billion. If they keep generating the cash flow they did during the first half of 2007, the double-digit free cash flow yield could be enticing.
The problem with those valuations, though, is that they rely on the accounting numbers on the face of the financial statements. The last 10Q disclosed that after the June 30 financial statement dates but before July 31, the company issued another $66 million in debt and paid $303 million cash to terminate pension plans and settle some other obligations. Then, on August 28 they were required to issue $650 million in debt to their pilots in exchange for salary concessions they had made. The company has settled $11.4 billion of bankruptcy claims by issuing common stock, but “currently estimate that the total allowed general, unsecured claims in our Chapter 11 proceedings will be approximately $15 billion, including claims with respect to which we have issued or commenced distributions of common stock.” That means that another $3.6 billion are not yet on the books, even assuming their estimate is correct. That brings the enterprise value to $14.3 billion, and the free cash flow yield below 7%. Who knows how many shares will have to be issued to settle the claims, so I won’t even talk about the P/E.
What’s more, airlines are notorious for off-balance sheet and other obligations. Delta has 136 aircraft under operating leases, which make up about a quarter of its fleet but do not appear on the balance sheet. If these were treated as company-owned aircraft, the assets and liabilities would each increase by about $3.5 billion (assuming the leased aircraft are worth about as much, on average, as those that are owned.) Now we’re down to a 5.4% yield on an adjusted enterprise valuation of $18.8 billion.
How quickly we get from something that looks enticing to something that looks like it came out of bankruptcy five months ago. Which, of course, it did. Bottom line, if you want to take a flier on an airline, I’d stick with one of the short squeeze plays. The majors still look like they can cause a major league stomachache.
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