I do not own any of the stocks mentioned in this article.

The airline sector sees a lot of turbulence. In this rocky environment, budget airlines have been hit especially hard. Delta Air Lines (DAL) is one of the “big boys.” Even so, the company’s stock has taken a hit. Following its Q2 earnings, there was an 8% drop in its stock price. Adjusted earnings-per-share were $2.36, which met expectations. The company had operating revenues of $16.7 billion, exceeding the $15.5 billion analysts expected. It also generated $2.7 billion in free cash flow, which enabled significant debt repayment.

So, what was the problem? Revenue growth was overshadowed by capacity outpacing demand, and operating expenses, including fuel costs, increased by 12%. Delta’s Q3 outlook follows a similar storyline, with lower EPS and capacity growth exceeding revenue. However, some analysts suggest that the reaction may be overblown and that the stock pullback will make DAL’s valuation more attractive.

A Regression To The Mean?

Airlines have many challenges, from macroeconomic issues like inflation and rising fuel costs to geopolitical tensions, climate change, and unexpected events like the pandemic. Budget airlines operating on tight margins get hit the worst. So far this year, Spirit Airlines (SAVE) has lost 81% of its value, while Frontier Group Holdings (ULCC) is down 21%. Southwest (LUV) lost 40% of its mid-2019 value in the past year. In its Q1 2024 report, JetBlue (JBLU) announced a GAAP loss of $2.11 per share. Inflation concerns lead to budget-conscious consumers taking fewer trips. Climate change means more extreme weather and delays, which for budget airlines that rely on high aircraft utilization, may force them to raise costs.

Zooming Out

Four airline companies now dominate the U.S. market with an 80% share—Delta Air Lines, United Airlines, American Airlines, and Southwest Airlines. Of these, Delta is seen as the most innovative. While legacy carriers like Delta have higher labor and operating costs for global travel and a diverse fleet, their slightly higher-priced first-class and business-class tickets allow them to offer better customer experiences. Delta has positioned itself as a premium airline—a must for legacy airlines to stay profitable.

Delta has some positives. Its forward P/E ratio of 7.2x is 30% below its 5-year average, and the Wall Street consensus remains strongly bullish. All 11 analysts covering the stock recommend buying, with an average price target of $63.07, implying a 40% upside potential.

Julie Stoller does not hold positions in any of the companies mentioned in this article. Stocks.News has positions in United Airlines.