Barron''s article


Aug 21, 2002
Taxiing for Takeoff
Turbulence batters airlines, but Delta, strongest of the lot, offers a promising speculative trip
This is a terrible time to run an airline. But it might be the right time to take a flyer on one.
Airline revenues have skidded more than 24% since 2000, owing to declines in passengers and fares since the Sept. 11 terrorist attacks. USAirways has filed for bankruptcy, UAL''s United Air Lines -- the world''s second-largest carrier -- could follow suit. And AMR''s American Airlines, the largest and the most prosperous in good times, is having immense problems in these bad times.
Which brings us to No. 3, Delta Air Lines, which has three major advantages over many big carriers.
The first is potential labor flexibility. Among Delta''s major employee groups, only its pilots are unionized. This should help it change work rules to boost efficiency and trim costs.
The second is a balance sheet that, while far from pretty, is a lot better than those of some of its battered rivals. In fact, Standard & Poor''s calls Delta financially the strongest of the major U.S. airlines, even while giving its bonds a junk rating of double-B.
The third is a hub-and-spoke route system that, while attacked as outmoded by critics, actually is quite valuable.
Certainly, no one should bet on Delta without considering the risks. While its stock, recently trading at about 12, looks cheap compared with its 52-week high of 38.69, it''s already had a nice run from the 52-week low of 6.10 it reached about a month ago. And keep in mind that the company lost $326 million, or $2.67 a share, in the third quarter, pushing its nine-month loss to $909 million, or $7.46 a share. For the full year, the loss may well exceed 2001''s $1.2 billion ($9.99 a share) net deficit. Excluding special charges, the loss was $8.46 a share last year. In 2003, Delta still could lose more than $4 a share, even if the economy permits a turnaround in the second half.
However, there were some positives in the quarter. For one thing, Delta is flying just about as many people every day as it did before 9/11, although they''re paying less. Revenue edged up 0.6%, to $3.42 billion, while operating expenses rose 4.3%, to $3.8 billion. Cash flow was break-even, and some of the loss came from unusual items, such as a $139 million noncash write-off on MD-11s and Boeing 727s Delta is taking out of service to reduce capacity while retaining the same number of flights.
On the other side of the unusual-item ledger, Delta won''t be receiving any more relief payments from Uncle Sam, like the $22 million received in the third quarter. But without any unusual items, the quarterly loss would have been lower -- $212 million, or $1.75 a share.
With its debt at $9.2 billion, or 83% of total capital, Delta had to renegotiate its credit lines recently to avoid violating covenants with its banks. A major reason for this: declines in pension assets, plus rising pension liabilities. Delta will have to take a noncash write-off of at least $400 million in shareholders'' equity this year, with more in later years unless the pension investments recover. The new line-of-credit terms require the airline to keep $1 billion in cash on hand; Delta has $1.9 billion.
The carrier has other resources, too, notably $5 billion in unencumbered, mortgageable assets. Its chief financial officer, M. Michele Burns, says the Atlanta-based airline could raise $2 billion or more through sale-leasebacks or other means if that were necessary. And she notes that the pension gap needn''t be filled at once. The next requirement is for a $250 million cash injection by 2004''s first quarter.
To cut costs, the company is eliminating 7,000 jobs, reducing some service and deferring $1.3 billion in aircraft deliveries from Boeing -- which was to send 29 planes in 2003 and ''04 -- until 2005. Delta still has orders and options with Bombardier for as many as 58 Canadair regional jets in 2003 and 66 in 2004 for its Atlantic Southeast Airlines and Comair units, which feed small-market traffic to its hubs. These $1.6 billion in commitments probably could be deferred, too.
Operating domestic hubs at Atlanta, Dallas, Salt Lake City and Cincinnati, Delta offers passengers geographic convenience that no other domestic airline can match.
Current wisdom holds that hubs are inefficient because planes spend too much time on the ground, crews spend too much time waiting for peak periods, and passengers won''t pay to change planes. Delta''s chief operating officer, Fred Reid, answers: That may have been true of the original concept, but we have advanced the concept far beyond that stage.
Delta has increased the number of banks -- peak periods in which all the planes arrive, everybody changes flights, and all the flights leave again. The day starts earlier and ends later, and there are fewer flights in each bank. Result: Ground crews can be smaller, but must work harder and longer -- something made possible by the airline''s labor flexibility.
Delta also organized its banks directionally: Flights at Hartsfield Atlanta International Airport, for example, arrive from the south and go north and west one hour. The next hour they arrive from the north and west and go south. We offer more flights in the direction passengers want to go, improving service, says Reid. That will pay off when traffic improves.
In short, while Delta has serious challenges ahead, it isn''t a basket case.
That said, speculators -- not investors -- should find the company worth a look. In fact, some argue, the airline industry''s fortunes wouldn''t have to improve much for the stock to hit 20.
Others, however, might rather play Delta''s debt securities. Delta''s 10 3/8% 20-year bonds have been trading at 53% of face value, producing a current yield of nearly 19.5%. If the airline pays off those bonds at maturity in 2022, the total yield to maturity would be even better. And if all goes awry, bondholders have a much better standing in bankruptcy court than do stockholders, who could lose every cent they''ve invested in the company.
The carrier also has exchange-traded hybrid securities, Delta 8.125% notes. These unsecured debt instruments, offered originally in 1999 at $25, trade on the Big Board and provide an annual payment of $2.03, paid quarterly. Early in October, their price plunged to $6.40, which brought buyers a current yield of 31.7%. Recently, in line with the rise in Delta stock, they were quoted at $15.20, still good for a 13.4% yield. The notes mature in 2039, although Delta can redeem them at par after July 1, 2004.
The key to a comeback for Delta or any airline is an increase in revenue. Adjusting for inflation, fares are down 45% since deregulation took hold 25 years ago. Competition is responsible. If the industry''s health doesn''t improve, some carriers, such as USAirways, may finally go out of business. Or Washington may allow mergers that would still give passengers two or three choices on each route while allowing carriers to make a profit.
That, however, will take a while. In the short term, anyone who takes a flyer on Delta might be wise to cash out after the industry''s cycle turns upward, boosting prices of its shares and bonds.

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