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Stock Analyst Update

Clearer Skies for Airlines

Bellwether Delta's results are encouraging, and we think airline stocks could be poised for a strong second half in 2018 due to falling fuel prices.

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No-moat  Delta Air Lines (DAL) reported fourth-quarter and full-year 2017 results. We’re encouraged by the evolution in passenger revenue per available seat mile, which grew 4.9% this quarter on a year-over-year basis due to firming yields and robust load factors. Against this backdrop of improving pricing, we think airline stocks could be poised for a strong second half in 2018 due to falling fuel prices. We’re planning to raise our fair value estimate for Delta by about $3 because of a slightly improved 2018 outlook, a lower tax rate, and the time value of money.

Operating revenue in the quarter stood at $10.2 billion, increasing 8% compared with 2016 on the back of strong mainline passenger revenue growth of 8% and other revenue growth, which includes ancillary sales, of 18%. Delta, which was guiding to operating margins of 11%-13% this quarter, landed at 11.6%. Diluted EPS came in at $0.80, which includes a revaluation charge on deferred tax assets and liabilities. Operating cash flow grew nearly $800 million to $1.9 billion due to better working capital management. For full-year 2017, operating revenue grew 4% thanks to 4% passenger revenue growth and 10% other revenue growth. Operating margins contracted 270 basis points in 2017 to 14.8% primarily due to higher fuel and labor cost pressures coupled with modest unit revenue growth. Full-year EPS came in at $4.95 (adjusted $4.93) down 14.5% versus 2016.

Management gave a midpoint pretax margin forecast of 7% for the first quarter, which represents a 300-basis-point contraction compared with 2017. Total unit revenue growth was pegged at a midpoint of 3.5% for the first quarter. The March quarter should be peak unit cost growth for Delta (forecast at 3% year over year) and over the rest of 2018, management aims to keep unit costs excluding fuel growing at 0%-2%. We also expect accelerating capacity growth across the industry to materialize, as evidenced by Delta's plans to grow capacity 3% during the first quarter.

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Chris Higgins does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.