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Delta's projected market capitalization is pie-in-the-sky
By Vaughn Cordle, CFA / May 2007
Delta’s management has done an outstanding job of bringing the company through bankruptcy. It has
reduced debt by over 50%, employee morale is high, and increased expenditure on improved customer
service is likely to give the company a competitive advantage and should result in higher average
yields. The company's strategy is to shift many of its wide-bodied aircraft out of the domestic market
and into the more profitable international markets.
Although the company left billions of dollars on the table by turning down US Airway’s merger offer, CEO
Grinstein has done the right thing for his employees. If oil prices fall, and the economy picks up in a
year or two, the company should do well. The company's debt will be rated a single B, so the challenge
will be to pay down debt and move toward a double or triple B rating. No easy task in the dysfunctional
and wealth-destroying airline industry.
Delta's when-issued share price closed at $20.75 during its first day of trade on May 3, 2007. This
implies that the company’s market value is $8.3 billion, not [management's] projected $10 billion, a
value management used to fend off US Airway's hostile offer, initially valued at $10.2 billion.
A share price of $15 implies a $6.4 billion market cap, which is consistent with peer group valuations. In
view of the weak domestic market and higher fuel costs, we think Delta's plan market capitalization
projection is pie-in-the-sky.
billion - $2.4 billion less than the Street’s $5.9 billion. Profits are higher next year for the industry and
Delta, but the company’s $1.5 billion earnings estimate is much too high, and this figure does not
represent GAAP earnings. We think the reported net will be less than half this amount and the market
will value the shares based on GAAP earnings.
will value the shares based on GAAP earnings.
Expect to see lots of "buy" ratings initially from sell-side analysts who work for firms (including most of
the brand-name Wall Street firms) that have financial relations with the company and make a market in
the stock. The high initial share price and "implied" market value will be a function of a small float of
shares that are available to trade.
Delta management is rewarding employees with a one-off 8% salary bonus and 3.5% of the shares.
Moreover, management prioritized and improved customer service while in bankruptcy and plans higher
capital expenditures on upgrading customer service than the other major airlines. This should provide
a competitive advantage, even if Delta's costs are still too high in the domestic market.
Bottom line: Delta's projected $10-billion market value is much too rich, given peer group valuation.
American is valued at $6.3 billion; United and Continental are in the $3.1 to $3.3-billion range. In relative
terms, Delta's projected market cap of $10 billion would put the company's value at twice that of its peer
group, even though net earnings will be in the lower half of the pack.
AirlineForecasts estimates that a slowing economy will result in a reduction of $700 million in the
industry’s domestic market revenues, which suggests Delta's revenue estimates are too rosy by
around $100 million. The industry's domestic capacity was a negative 3.5% in 2006 and this is why
yields increased 5%. Domestic capacity is estimated to grow around 3% this year and we believe that
industry yields will resume their long-term [inflation-adjusted] decline. Moreover, yields in the Atlantic
market will fall as capacity grows too fast over the next few years, which also suggests revenue
projections are too high.
Smart traders will short the company if shares move materially above $20, which is possible given the
initial enthusiasm from emerging from bankruptcy and the small [initial] share base "float" relative to
total number of shares outstanding. The NYMEX forward curve has oil averaging $67 for the rest of the
year and $70 in 2008. The forward curve is highly volatile and can turn on a dime. Most analysts have
revised oil estimates from $60 to $65.
By Vaughn Cordle, CFA / May 2007
Delta’s management has done an outstanding job of bringing the company through bankruptcy. It has
reduced debt by over 50%, employee morale is high, and increased expenditure on improved customer
service is likely to give the company a competitive advantage and should result in higher average
yields. The company's strategy is to shift many of its wide-bodied aircraft out of the domestic market
and into the more profitable international markets.
Although the company left billions of dollars on the table by turning down US Airway’s merger offer, CEO
Grinstein has done the right thing for his employees. If oil prices fall, and the economy picks up in a
year or two, the company should do well. The company's debt will be rated a single B, so the challenge
will be to pay down debt and move toward a double or triple B rating. No easy task in the dysfunctional
and wealth-destroying airline industry.
Delta's when-issued share price closed at $20.75 during its first day of trade on May 3, 2007. This
implies that the company’s market value is $8.3 billion, not [management's] projected $10 billion, a
value management used to fend off US Airway's hostile offer, initially valued at $10.2 billion.
A share price of $15 implies a $6.4 billion market cap, which is consistent with peer group valuations. In
view of the weak domestic market and higher fuel costs, we think Delta's plan market capitalization
projection is pie-in-the-sky.
billion - $2.4 billion less than the Street’s $5.9 billion. Profits are higher next year for the industry and
Delta, but the company’s $1.5 billion earnings estimate is much too high, and this figure does not
represent GAAP earnings. We think the reported net will be less than half this amount and the market
will value the shares based on GAAP earnings.
will value the shares based on GAAP earnings.
Expect to see lots of "buy" ratings initially from sell-side analysts who work for firms (including most of
the brand-name Wall Street firms) that have financial relations with the company and make a market in
the stock. The high initial share price and "implied" market value will be a function of a small float of
shares that are available to trade.
Delta management is rewarding employees with a one-off 8% salary bonus and 3.5% of the shares.
Moreover, management prioritized and improved customer service while in bankruptcy and plans higher
capital expenditures on upgrading customer service than the other major airlines. This should provide
a competitive advantage, even if Delta's costs are still too high in the domestic market.
Bottom line: Delta's projected $10-billion market value is much too rich, given peer group valuation.
American is valued at $6.3 billion; United and Continental are in the $3.1 to $3.3-billion range. In relative
terms, Delta's projected market cap of $10 billion would put the company's value at twice that of its peer
group, even though net earnings will be in the lower half of the pack.
AirlineForecasts estimates that a slowing economy will result in a reduction of $700 million in the
industry’s domestic market revenues, which suggests Delta's revenue estimates are too rosy by
around $100 million. The industry's domestic capacity was a negative 3.5% in 2006 and this is why
yields increased 5%. Domestic capacity is estimated to grow around 3% this year and we believe that
industry yields will resume their long-term [inflation-adjusted] decline. Moreover, yields in the Atlantic
market will fall as capacity grows too fast over the next few years, which also suggests revenue
projections are too high.
Smart traders will short the company if shares move materially above $20, which is possible given the
initial enthusiasm from emerging from bankruptcy and the small [initial] share base "float" relative to
total number of shares outstanding. The NYMEX forward curve has oil averaging $67 for the rest of the
year and $70 in 2008. The forward curve is highly volatile and can turn on a dime. Most analysts have
revised oil estimates from $60 to $65.
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