Despite the potential upside, wait until Delta falls below book value

<p>Delta Air Lines (NYSE: DAL) is in survival mode. The DAL stock has fallen 62% from its 52-week high and decreased by 59% from the beginning of 2020. But there seems to be some light at the end of the tunnel.

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The situation is very dark for Delta, as with many other airlines. On April 22, Delta reported an adjusted pre-tax loss of $ 400 million in March. In addition, the airline expects 90% less revenue during the June quarter compared to a year ago.

This means that the company will lose money for a good while. Delta said it burned $ 100 million a day at the end of March. Management expects this to improve to just $ 50 million per day by the end of June.

Keep in mind that for most airlines, a load factor of 75% for each flight is the equilibrium level. Delta reported that its passenger capacity in March was 73.1%. But it mainly reflects normal loads during the earlier part of the quarter. Reaching even load factors will not happen for a long time.

About that light at the end of the tunnel

Delta reported that it had $ 5.967 billion in cash at the end of March. The problem is that burning $ 75 million a day (the average between $ 100 million a day burns at the end of March and $ 50 million at the end of June) will cost $ 6.75 billion. In other words, Delta Air Lines will run out of cash.

So the company will need to raise more money. Reuters reported on April 25 that the US Treasury Department had just sent $ 9.5 billion in additional payroll support programs to US airlines. In total, the four largest US airlines receive $ 19.25 billion. Delta is expected to receive $ 5.4 billion in total state aid, according to CNBC, including loans and grants.

OK. Good. But you can see that $ 5.4 billion will still only last for 108 days to $ 50 million in daily cash burn. It’s a little longer than a quarter, to say 30 September. In addition, it is possible that it may already have been in the balance sheet in March.

So where is the light? First, after September 30, 2020, Delta can take measures to release employees that the government says they cannot compete for or postpone at the moment. Delta has 90,000 employees. It will need to bring the cash burn rate to zero or less very soon after the end of that month.

One way would be to cut out a large part of its staff base. For example, Delta spent $ 2.77 billion in salaries and related expenses during the first quarter. That equates to $ 30.45 million per day, or 60.9% of the estimated daily combustion rate of $ 50 million at the end of June.

Delta will need to reduce its costs dramatically after September.

Expected Finances Uptick would help

Another element of light is that the economy will start to pick up at the end of the third quarter, with load factors that have probably increased when different states leave quarantine restrictions.

In addition, if oil prices remain low in the coming quarters, it will also help to reduce the daily burning rate.

But, of course, there is no guarantee that these factors will last. In addition, it is possible that until a vaccine is found, there may be further bloating in cases of new coronavirus. This can dampen a recovery in demand for travel, especially business travel. Airlines make up to 75% of their profits from business travel.

Repurchase of shares

People are upset that Delta and other airlines have spent so much on share repurchases. But now companies are fighting for their survival. Can this affect companies from making repurchases in the future?

Business Insider recently published an interesting video article about the money wasted on repurchases, including Delta. The report noted that Delta spent $ 11.4 billion on repurchases over the past seven years, including more than $ 2 billion in 2019 alone. Business Insider said Delta spent $ 11.2 billion in 2019 on salaries and related expenses. The point they make is that if cash had been left to accumulate, the company would not necessarily be in survival mode right now.

I think there is some truth in this. From here, I suspect that companies in highly cyclical or disruptive industries may become more conservative when it comes to their repurchase policies. After all, this is what steel and car manufacturing companies have been doing for a long time.

This means that the potential rise for DAL shares, even after the company returns to profitability, may be hampered. Now you can see that the stock returns to its previous highs for a very long long time.

What should DAL equity investors do?

One thing that prevents me from buying DAL shares right now is that the share is traded for its book value per share. For example, equity at the end of March was $ 14.3 billion. By comparison, the market value of the Delta share is now $ 14.29 billion, or about the same value as book value.

There were 637,836 million shares in DAL shares outstanding at the end of March 2020, according to the latest filing by SEC 10-Q. This means that its book value per share was $ 22.43 per share. At a price of $ 22.41, DAL is traded at 0.999 times book value per share.

I simply do not think it reflects the inherent risk that the company faces in the future. The company could not even project when it will be profitable or where its even load factor would be in the next few quarters.

If you are a value investor, I would wait for the DAL share to be traded for half to two thirds of the most recent book value per share. At that time, you can measure if the light at the end of the tunnel is more than just a spot. Even more important is that you can assess the probabilities of the up and down risks.

At the time of writing, Mark Hake, CFA holds no position in any of the above securities. Mark Hake runs the Total Yield Value Guide which you can review here.