UBS estimates that Delta Air Lines, Inc.'s (NYSE:DAL) updated Q2 EBIT margin guidance (18-19%) implies EPS in the $1.60-1.75 range. Midpoint approximates consensus expectation at ~$1.67, but is below the firm’s estimate on higher fuel and non-fuel operating expenses along with slightly higher non-op and share count. The firm would note that Delta Air Lines updated guidance for 4-6% CASM ex fuel growth is presented on a normalized basis for its Q4'16 pilot contract and implies 7-8% CASM ex fuel growth on a reported basis.
Delta Air Lines guidance for 2.5% Q2 PRASM growth is in line with the firm’s forecast. UBS models 3.5% PRASM growth for Delta Air Lines in Q3, and its base-case EPS estimate at $1.85 is ~6% ahead of consensus at $1.74. The firm sees potential upside to ~$2.00 in Q3 EPS assuming typical seasonal PRASM trend holds up, which would represent ~15% upside to consensus. More specifically, Delta Air Lines Q3 PRASM has held ~flat sequentially on average since 2007 (~13.1c on average). Sequentially flat PRASM in Q3'17 (~13.9c) would imply 5-6% y/y PRASM growth and ~$2.00 in EPS. Alternatively, in its downside scenario, assuming Delta Air Lines PRASM growth decelerates to ~1.5% in Q3, the firm still gets to ~$1.70 in EPS, which is only ~2% below consensus.
UBS is reducing its 2017-18 EPS estimates, primarily as a result of recently higher fuel. Despite higher Q2 cost growth, the firm’s full-year 2017 CASM ex fuel growth forecast is unchanged at 2.5%, in line with Delta Air Lines guidance. It estimates that guidance midpoint implies a ~1% CASM ex fuel decline in 2H (+1% normalized for pilots) as compared with 6%+ growth in 1H (4%+ normalized). The firm models ~3% growth in Q3 (+1% normalized), followed by a ~5% decline in Q4 (+1% normalized).
While the firm’s EPS estimates move lower, its PT is unchanged as the market has proven unwilling to pay for fuel-driven earnings growth anyway. It now targets a ~13.5x multiple (~13x prior) on its 2018 unlevered FCF (FCFF) estimate at ~$4.2B ($4.4B prior), normalized for capex (~$3.2B/year) and cash tax rate (~35%). The stock has run up recently, but the firm continues to view Delta Air Lines as under-valued relative to other cyclicals.