delta air lines inc. company report · waterfall chart in figure 1 giving a precise breakdown of...

THIS REPORT WAS PREPARED BY MICHAEL LÜFFE, A MASTERS IN FINANCE STUDENT OF THE NOVA SCHOOL OF BUSINESS AND

ECONOMICS, EXCLUSIVELY FOR ACADEMIC PURPOSES. THIS REPORT WAS SUPERVISED BY ROSÁRIO ANDRÉ WHO REVIEWED THE

VALUATION METHODOLOGY AND THE FINANCIAL MODEL. (SEE DISCLOSURES AND DISCLAIMERS AT END OF DOCUMENT)

See more information at WWW.NOVASBE.PT /32

MASTERS IN FINANCE

EQUITY RESEARCH

A flight, investors should board

Capacity discipline continues to be key profit driver

For the past two years Delta Air Lines has been

generating benchmark returns that other US legacy carriers were

struggling to keep up with.

Going forward the airline will have to increasingly invest

in the replacement as well as expansion of its aircraft fleet which

is one of the oldest in the industry. Higher capital expenditures

will inevitably come at the expense of shareholder cash returns.

Even against the backdrop of rising crude oil and jet fuel

prices, operating margins are forecasted to remain in a range of

14% to 18% until 2025. This is subject to the condition that the

US airline industry remains disciplined about capacity growth and

that unit revenues in Delta’s international markets continue to

recover.

Valuation: We recommend buying Delta Air Lines given

our price target for year end 2017 of $61.74 per share, offering

investors an upside potential of 24.15% to the current share price

of $49.73.

Company description

Delta Air Lines, Inc., founded in 1924 and headquartered in Atlanta, Georgia, offers air transportation services to passengers and cargo throughout the United States and on international routes. Furthermore, the company runs an oil refinery which provides its north eastern US airline operations with jet fuel. As of today, the company and its global alliance partners offer air travel services to 323 destinations in 57 countries across all six continents.

DELTA AIR LINES, INC. COMPANY REPORT

INDUSTRIALS 6 JANUARY 2017

STUDENT: MICHAEL LÜFFE (#972) [email protected]

Recommendation: BUY

Price Target FY17: 61.74 $

Price (as of 6-Jan-17) 49.73 $

Reuters: DAL.N, Bloomberg: DAL:US

52-week range ($) 33.36-51.78

Market Cap ($m) 37,335.00

Outstanding Shares (m) 736.39

Source: Yahoo Finance

Source: Fidelity, 06.01.2017

(Values in $ millions) 2015 2016F 2017F

Revenues 40,704 40,861 41,329

EBITDA 9,637 10,738 9,094

EBITDA margin 23.68% 26.28% 22.00%

Net Profit 4,526 5,373 4,335

Net profit margin 11.12% 13.08% 10.49%

Basic EPS 5.68 7.26 6.01

ROIC 25.69% 19.34% 18.14%

Capex 2,945 2,809 3,598

Current ratio 0.52 0.60 0.59

Sales per share 51.07 55.49 57.27

Source: Company Data, Analyst’s Estimates

http://www.novasbe.pt/


PAGE 2/32

Table of Contents

COMPANY OVERVIEW ........................................................................... 3

COMPANY DESCRIPTION ....................................................................................... 3 SHAREHOLDER STRUCTURE ................................................................................. 4

ANALYSIS OF REGIONS/MARKETS ...................................................... 6

NORTH AMERICA................................................................................................... 6 LATIN AMERICA ................................................................................................... 12 ATLANTIC ............................................................................................................ 13

THE AIRLINE INDUSTRY .......................................................................14

FIVE FORCES ....................................................................................................... 14 Competition ....................................................................................... 14 Industry entry and exit ..................................................................... 15 Substitute and complement products or services ........................ 16 Supplier power .................................................................................. 17 Buyer power ...................................................................................... 18

COMPETITIVE ANALYSIS ......................................................................19

SWOT ANALYSIS ................................................................................................ 19 Strengths ........................................................................................... 19 Weaknesses ...................................................................................... 20 Opportunities ..................................................................................... 21 Threats ............................................................................................... 21

RISKS TO THE INVESTMENT THESIS ..................................................22

EXTERNAL RISKS................................................................................................. 22 INTERNAL RISKS .................................................................................................. 23

FINANCIAL OUTLOOK ...........................................................................24

DIVIDEND POLICY ................................................................................................ 24

VALUATION ............................................................................................24

WACC APPROACH ............................................................................................. 24 MULTIPLES .......................................................................................................... 25

APPENDIX ..............................................................................................26


PAGE 3/32

Company overview

Company description

Founded in 1924 as an aerial crop dusting operation, Delta Air Lines, Inc. (NYSE:

DAL) is nowadays one of the largest US carriers and a globally operating airline,

that employs 84,000 people worldwide, manages a mainline fleet of more than 800

aircraft and offers air travel services to nearly 60 countries all over the world.1 Since

2012 the Atlanta-based company has split its operating activities into two distinct

segments, airline and refinery, whose relative importance as measured by

operating revenues has been very different, a fact that is highlighted by the

waterfall chart in Figure 1 giving a precise breakdown of consolidated revenue in

2015. Delta’s airline segment provides air transportation both for passengers and

cargo throughout the United States as well as to and from international

destinations. With a CAGR2 of 6.52% since 2009 and an 85% share of operating

revenue in 2015, passenger air travel has been an important value driver for Delta

Air Lines, while cargo’s CAGR of 0.52% reflects the massive decay that this

particular business division has been in for more than four years. Figure 2 further

visualizes the evolution of operating revenue. Delta’s extensive route network is

based on a system of domestic hubs, most important of which are Atlanta, Boston,

Detroit, Los Angeles, Minneapolis-St. Paul, New York JFK, New York LaGuardia,

Salt Lake City and Seattle, as well as international gateway airports, such as

Amsterdam, London-Heathrow, Paris-Charles de Gaulle and Tokyo-Narita. Delta’s

operations in these markets include flights, gathering and distributing traffic from

the geographic regions surrounding the hub or gateway to domestic or

international cities or other hubs and gateways. Figure 3 provides an overview of

the percentages of Delta’s total domestic flights and passengers that were

processed through each one of its nine US hubs in 2015. The fact that an

astonishing 60% of inland flights and passengers were apportioned to these hubs

indicates a strong dependency that has persisted for more than five straight years

and suggests a fundamental operational risk.

In addition to air transportation, the airline segment provides other ancillary airline

services, such as maintenance and repair services (MRO) for third parties. Delta’s

air travel services are sold through various distribution channels, including

1 http://news.delta.com/corporate-stats-and-facts 2 The mean annual growth rate over a time period longer than one year is referred to as compound annual growth rate. It is calculated by dividing the value at the end of a period by the value at the beginning, raising it to the power of one divided by the length of the period and subtracting one from the result.

Figure 1: Operating revenues by segment 2015 (in million USD)

Source: Company Data

Figure 2: Operating revenues 2009-2015 (in million USD)

Source: US Bureau of Transportation

Figure 3: Delta’s US hubs’ share of 2015 domestic passengers and flights apportioned to hubs


http://news.delta.com/corporate-stats-and-facts


PAGE 4/32

telephone reservations, online travel agencies and digital channels, such as mobile

and delta.com.

Delta’s refinery segment produces gasoline, diesel and jet fuel. Its wholly owned

Monroe Energy subsidiary runs the Trainer refinery located near Philadelphia,

Pennsylvania. The refinery facilities include pipelines and terminal assets allowing

the supply of jet fuel from its own production as well as from third party suppliers

Phillips 66 or BP to the airline segment.3

As of October/November 2016 the flight network of Delta Air Lines encompasses

a total of 2,052 routes. These can be split into 64% domestic routes, connecting

cities in the contiguous and non-contiguous United States or their insular

territories, and 36% international routes. Figure 4 shows that the majority of

international routes cover the trans-Atlantic region, followed by the Latin American

and the Asian/Pacific region. Figure 5 indicates Delta’s strong positioning in its

core market United States, where its trailing twelve months’ market share

amounted to 16.8% as of end of September 2016. Only American Airlines and

Southwest Airlines were able to claim a bigger share of the domestic market.

In 2015 Delta boarded almost 180 million passengers. The airline is a founding

member of the SkyTeam global airline alliance and participates in the industry

leading transatlantic joint venture with Air France-KLM and Alitalia. Counting its

worldwide alliance partners, Delta offers customers more than 15,000 flights per

day. By total revenue and capacity, Delta Air Lines is the second largest US carrier

after American Airlines.

Like the other US network carriers American Airlines and United Airlines, Delta

incurred significant operating losses in the early 2000s. These were not only the

result of a strongly receding travel demand in the aftermath of the 9/11 attacks,

both at home and abroad, but were to a great extent also caused by the effects of

an over-competitive airline industry. In 2005, the new Delta Air Lines emerged from

Chapter 11 bankruptcy proceedings and in the same year merged with Northwest

Airlines.

Shareholder structure

Figure 6 states that the shareholder structure of Delta Air Lines is largely

dominated by institutional owners, which held approximately 83% of the company’s

outstanding shares by the end of the third quarter 2016.4 Such a high ownership

stake of institutional investors may impact the company’s stock price in many

3 http://www.reuters.com/finance/stocks/companyProfile?symbol=DAL.N 4 https://eresearch.fidelity.com/eresearch/evaluate/fundamentals/ownership.jhtml?stockspage=ownership&symbols=DAL


Figure 5: Trailing twelve months’ (TTM) domestic market share of US airlines

Figure 4: Division of Delta’s route network into four geographic regions


Source: Fidelity, 13.11.2016

Figure 6: Shareholder structure in % of total shares outstanding as of Q3 2016

http://www.reuters.com/finance/stocks/companyProfile?symbol=DAL.N

https://eresearch.fidelity.com/eresearch/evaluate/fundamentals/ownership.jhtml?stockspage=ownership&symbols=DAL


PAGE 5/32

different ways, good and bad. In general, a high percentage of institutional

ownership signifies a strong shareholder base as investors are usually in for the

long haul and, unless they are momentum investors, endure periods of downturn.5

There has been only a slight change of institutional ownership percentage in 2016.

Financial institutions sold more shares than they purchased, leading to a drop in

ownership of 1.94%. Given the distinct research capacities that investment banks

or fund managers have at their disposal, they are considered to be well informed

and to make reasonable investment decisions. In terms of marketing, Delta

achieves a multiplier effect by getting large institutions to go long its stock. JP

Morgan, for example, advertises its holdings in Delta’s stock in order to create

interest in them and boost the stock price. With regards to their corporate

governance function, institutional investors can positively influence the company

by monitoring management decisions and applying pressure if need be.6

Nonetheless, an institutional investor majority can equally be a burden to the

company and hamper its performance. In view of institutions’ thorough research

on security and industry fundamentals, any position they take is evaluated by the

market as a justified response to a change in the stock’s projected value. However,

institutional buy or sell transactions are often merely motivated by arbitrage or

short-term market inefficiencies and not necessarily supported by underlying

fundamentals.7 This market behavior can easily trigger a sell-off and destroy value,

especially in light of the enormous amount of shares that have to be absorbed by

the market in case several institutional investors act at the same time. The

compensation of fund managers is usually based to a large degree on the profits

they generate and their performance is evaluated against a group of benchmark

indices. This system promotes short-term investing, such as the sale of temporarily

underperforming stocks, which drives up their volatility.8 In the case of Delta this

could have contributed to a higher systematic risk parameter, given through a

levered beta of 1.26, which is slightly above our calculated US airline industry

average of 1.25.

Recent research on the airline industry suggested that common institutional

ownership among major U.S. airlines has a tremendous impact on airfares, which

led the Department of Justice to investigate. Due to the fact that companies such

as Delta, American, United or Southwest are all controlled by a small number of

institutional investors, the price competition is likely to be less intensive. Even

5 https://www.thestreet.com/story/1039002/1/what-short-interest-and-institutional-ownership-tell-you.html 6 http://www.slate.com/articles/news_and_politics/view_from_chicago/2015/04/mutual_funds_make_air_travel_more_expensive_institutional_investors_reduce.html 7 http://www.money-zine.com/investing/investing/understanding-stock-ownership/ 8 http://www.investopedia.com/articles/stocks/07/insitutional-owners.asp

https://www.thestreet.com/story/1039002/1/what-short-interest-and-institutional-ownership-tell-you.html

http://www.slate.com/articles/news_and_politics/view_from_chicago/2015/04/mutual_funds_make_air_travel_more_expensive_institutional_investors_reduce.html


http://www.money-zine.com/investing/investing/understanding-stock-ownership/

http://www.investopedia.com/articles/stocks/07/insitutional-owners.asp


PAGE 6/32

though investors do not actively dictate prices or interfere with an airline’s operating

business, airfares were shown to be three to five percent higher because of cross-

shareholding.9 If for instance Delta and United are the sole competitors on selected

routes, both the fund investing in Delta as well as United and the managers working

at the two carriers benefit from higher prices and higher profits.10 As of September

30, 2016, five of the top ten institutional investors in Delta, American and United

were the same.

Analysis of regions/markets

Delta Air Lines offers air travel services to four different geographical regions,

which are North America, Latin America, Atlantic and Pacific. Each of these regions

has unique economic potential for airlines to grow and a different competitive

situation, which are two crucial factors that impact Delta’s valuation going forward

as they are reflected in the amount of revenue generated. Figure 7 shows the

development of Delta’s passenger revenue by geographical regions from 2009 to

2015. Figure 8 specifies the percentage breakdown of these regions in 2015.

North America

In spite of Delta’s global presence, the North American region is still its most

important market. Key figures even indicate that it will continue to be for the

foreseeable future. Since 2009 the share of passenger revenue generated in this

market has increased from approximately 45% to over 50%. Also it is the North

American region that Delta traditionally achieves its best load factors in. In terms

of Delta’s flight network, roughly two-thirds are domestic routes as of

October/November 2016. And on top of this the domestic market accounted for

61% of Delta’s air travel capacity.

As of year-end 2015 North America was the second largest region based on

capacity with a 25.3% share of the world total, second only to Asia/Oceania with

and slightly ahead of Europe, as Figure 9 proves. However, North America’s

growth in capacity, measured in available seat miles (ASM)11, or other metrics,

9 http://www.nytimes.com/2016/04/13/business/dealbook/rise-of-institutional-investors-raisesquestions-of-collusion.html?_r=0 10 http://www.slate.com/articles/news_and_politics/view_from_chicago/2015/04/mutual_funds_make_air_travel_more_expensive_institutional_investors_reduce.html 11 ASM quantify the amount of capacity offered by an airline. It is the number of seats available for transporting revenue-paying passengers multiplied by the total number of miles flown over the course of a reporting period.

Figure 7: Passenger revenue 2009-2015 by regions (in million USD)


Figure 8: Percentage breakdown of passenger revenue 2015 by regions


Source: Oliver Wyman

Figure 9: World capacity October 2014-October 2015 by regions

http://www.nytimes.com/2016/04/13/business/dealbook/rise-of-institutional-investors-raisesquestions-of-collusion.html?_r=0

http://www.nytimes.com/2016/04/13/business/dealbook/rise-of-institutional-investors-raisesquestions-of-collusion.html?_r=0




PAGE 7/32

such as departures, average seats per departure or average stage-length, lag

considerably behind those of other world regions. ASM between October 2014 and

October 2015 were only up 4.6% compared to a year earlier. Growth in ASM was

primarily driven by a 3.5% increase in the seat average per departure and a 2.5%

increase of the average stage-length, while the number of scheduled departures

between October 2014 and October 2015 actually declined by 1.1%, as is shown

in Figure 10. Between October 2011 and October 2015, the decline in departures

even amounted to 5%, while seats per departure were up 4.7% and ASM 14%.

This development is in line with a general capacity trend for the North American

region in which smaller gauge regional jets, usually equipped with less than 70

seats, are continuously being replaced by larger and more fuel efficient aircraft

flying longer distances. This development is supported by the fact that as of

October 2015 North American airlines had placed orders for almost 2,000 aircraft

to be delivered until 2020 with half of the deliveries being for large narrow-body

aircraft with more than 160 seats. A look at the ratio between long haul and short

haul flights underlines this development. Of a 58 country sample, the United States

had the fourth largest share of long haul passengers in 2015, with almost 70% of

all domestic passengers travelling on flights that lasted at least three hours. Figure

11 compares the five previously mentioned world regions by their average share

of long haul as well as short haul passengers in 2015. For the whole sample, the

arithmetic average share of long haul passengers amounted to 29%.

Another significant air travel trend regarding the North American region is that

capacity from North America to other regions outgrew capacity within the region

by far, suggesting that US airlines have been expanding massively to Latin

America and the Caribbean. All in all, capacity growth metrics for North America

suggest that the region is the most mature of the five major world regions. There

seems to be overcapacity in the market because passenger load factors have been

declining since 2013. US airlines are reacting to this by trimming their capacity

expansion. Capacity growth within North America was below GDP growth for the

year 2015. Due to only moderately rising jet fuel prices, particularly value carriers

are forecasted to add capacity inside the region but even more so outside due to

their incorporating international flights in the otherwise domestically dominated

route networks.

Capacity and traffic numbers considered separately from each other do not

indicate a lot about the strategic direction Delta has chosen or its profitability in

certain markets. The metric passenger load factor, however, focuses on the ratio

between both numbers, thus allowing to properly evaluate ups and downs in the

utilization of Delta’s capacity. Appendix 1 shows that in terms of load factor, both

Source: Oliver Wyman

Figure 10: North America capacity changes October 2014/2015

Figure 11: Average share of long haul vs short haul passengers in 2015 by regions

Source: Passport


PAGE 8/32

domestic mainline and regional have improved from 2014 to 2015, lifting the

domestic region as a whole from 85.18% to 85.98%, a trend that has been

reversed in 2016. This is because US airlines have aggressively grown their supply

due to lower fuel costs and other facilitating circumstances.

Appendix 1 furthermore highlights that since 2014 the share of domestic mainline

capacity in relation to Delta’s total system capacity has risen by almost three

percentage points to 50.6%. Domestic regional capacity was further reduced, both

in absolute and relative terms, as it dropped to just over 10% of total system

capacity from above 11% back in 2014. This is the result of Delta’s efforts to be

less dependent on regional carriers, conducting flights under Delta Connection.

Table 1 shows that as of October/November 2016 the airline is still very much

reliant on regional carriers, as SkyWest, Endeavor Air or ExpressJet Airlines each

service about a fifth of Delta’s route network. It is also a natural outcome of capacity

relocation measures that airlines conduct on a monthly basis in order to have their

airplanes serve the most profitable or heavily-frequented routes. Delta’s significant

exposure to the US air travel market becomes first and foremost apparent given

that domestic mainline and regional capacity combine for a total of approximately

60% of Delta’s entire capacity.

As one of three major US legacy carriers that went into bankruptcy after 9/11 and

emerged out of it, Delta has maintained a substantial market share on domestic

flights for years. The merger with Northwest Airlines back in 2010 created what

was then the largest commercial airline in the world and solidified Delta’s

competitive position inside the United States as it pushed domestic market share

measured in revenue passenger miles (RPM)12 up by over six percentage points

to 16.6%. Since then Delta’s market share has remained relatively steady.

Measured by the share of all domestic flights in the United States Delta’s market

share in 2015 was 10.85%, a year-on-year increase of about 1% and more than a

doubling of the share registered in 2009. Due to their deteriorating financials and

competitive positioning inside the United States, further domestic carriers were

forced to consolidate, which led to the merger of United Airlines and Continental

Airlines in 2012 and the merger of American Airlines and US Airways in 2015,

raising the market shares of the two newly created companies to just over 16%.

Another major competitor for Delta is Southwest Airlines, one of the top low-cost

carriers in the country, which increased its market share by almost 5% within six

years to become the market leader as measured by RPM. Other important players

in the market are JetBlue Airways, SkyWest Airlines and Alaska Airlines, the latter

12 RPM are the number of revenue-paying passengers per reporting period multiplied by the number of miles they have been transported during the period. A synonym for RPM is traffic.

Operator No. of routes Pct. of total

Delta Air Lines 1,336 65.11%

Westjet 37 1.80%

Westjet Encore 4 0.19%

KLM 31 1.51%

Transavia 0 0.00%

Alitalia 14 0.68%

Air France 34 1.66%

Virgin Atlantic Airways 32 1.56%

Air Europa Lineas Aereas 4 0.19%

Aeromexico 40 1.95%

Aerolineas Argentinas 4 0.19%

Korean Air Lines 12 0.58%

Virgin Australia International 4 0.19%

China Southern Airlines 8 0.39%

China Eastern Airlines 11 0.54%

China Airlines 4 0.19%

Delta Connection

SkyWest 463 22.56%

Endeavor Air 451 21.98%

Expressjet 441 21.49%

Shuttle America 93 4.53%

Compass Airline 146 7.12%

Gojet Airlines 179 8.72%

Aeromexico Connect

Aerolitoral 21 1.02%

Selected Operators

Only Delta Air Lines 889 43.32%

Only Third Party Carriers 716 34.89%

Total Third Party Carriers 1,163 56.68%

Only Delta Connection 522 25.44%

Only Air France-KLM-Alitalia 46 2.24%

Only Equity Investments 65 3.17%

Table 1: In and outsourcing of Delta’s October/November route network



PAGE 9/32

of which endeavors to become the fifth largest US airline by the time its merger

with Virgin America has been completed. Not only since 2009 has consolidation

been a major trend for the airline industry. This may be demonstrated by the fact

that on routes within the United States the major 13 domestic carriers combined

for a total market share of 88.41% in 2015 after a mere 64.81% in 2009. Another

metric proving the significant market concentration in the United States is the

Herfindahl-Hirschman-Index (HHI). Considering the 13 biggest carriers’ market

shares on domestic flights, the HHI rose from 641.22 in 2009 to 1,165.05 in 2015.

Above an HHI of 1,000 a marketplace can no longer be characterized as entirely

competitive but moderately concentrated. Less competition has had a lasting

positive impact on US airlines’ capacity utilization and bottom lines.

Further analysis shows that Delta Air Lines operated 75.73% of its 2015 total of

875,000 domestic flights out of 29 major US airports. This share has gradually

decreased since 2009 when it amounted to 79.35%, which suggests that Delta has

been diverting to smaller, less-congested airports in an effort to save on fees for

airport slots and reduce overall costs. Almost 55% of the 875,000 flights were

executed through Delta’s seven major hubs Atlanta, Minneapolis-St. Paul, Detroit,

Salt Lake City, Los Angeles as well as both major New York airports JFK and

LaGuardia. Hartsfield-Jackson alone services around 28% of all domestic flights,

which bears enormous risk in light of the recent power outage at the airport in

August 2016 causing multiple delays and cancellations throughout Delta’s entire

network. Compared to United Airlines and American Airlines, Delta had less

exposure to the 29 major US airports in 2015 and therefore less operational risk

as United operated 85.9% and American 82.82% of its entire domestic flights

through those airports. However, Southwest Airlines only made 53.38% of its

domestic departures from one of the airports in question which is not surprising

given the low-cost business model and the point-to-point transit model Southwest

Airlines is practicing.

As highlighted by the map in Figure 13 below, which shows Delta’s 2015 market

shares on domestic flights at the 29 biggest airports, the airline has substantiated

a strong market position in the southeastern and mid-western United States. Its

top domestic routes, as measured by number of enplaned passengers between

October 2015 and September 2016, are listed in Figure 12. The merger with

Northwest Airlines back in 2010 has helped Delta to almost double the market

share on domestic flights in its southeastern hub Atlanta. Its local market share

rose from 34% in 2009 to 62% in 2015. In the same time span Delta achieved even

steeper market share gains of 30% or more on domestic flights in Salt Lake City

as well as on domestic and international flights in Detroit and Minneapolis-St. Paul.


Figure 12: Top domestic origin-destination city pairs based on enplaned passengers October 2015-September 2016 (in millions)


PAGE 10/32

More moderate increases between 5% and 10% were recorded on domestic flights

in Los Angeles, New York JFK, New York LaGuardia, Seattle/Tacoma and Tampa

and on international flights in Boston, Los Angeles and Portland.

Figure 13: Delta’s market share on domestic flights at 29 major US airports. (Source: US Bureau of

Transportation)

Considering domestic as well as international flights, Delta had a total market share

above 15% at five out of the 29 major US airports. These were Atlanta (57.95%),

Minneapolis-St. Paul (33.11%), Detroit (30.57%), Salt Lake City (30.5%) and New

York-JFK (18.77%). Furthermore, Delta was among the top five airlines in terms of

market share at 23 out of the 29 major airports. Only at airports in San Diego

(6.93%), San Francisco (5.14%), Newark (3.16%), Denver (2.8%), Chicago O’Hare

(1.77%) and Houston (1.31%), Delta had insignificantly small operations.

Since 2014 the price environment in the United States has been presenting

domestic airlines with a big challenge. Average round-trip airfares in the United

States have dropped tremendously from 2015 to 2016, as pointed out in Figure 14.

While an average itinerary fare, which corresponds to the ticket price charged by

the airline plus any additional taxes and fees surcharged by outside entities, cost

$392 in 2014, travelers had to pay only $377 in 2015 and $361 in 2016. Intense

price wars throughout the US airline industry have contributed to an overall decline

in revenues per available seat mile (RASM)13, yields and carriers’ load factors. In

2015 Delta Air Lines faced a slight drop in mainline unit revenues of 0.64% after

recording strong growth numbers in this segment between 2009 and 2014.

However, considering that from 2014 to 2015 unit revenues were down 3.01% for

all of its mainline operations and 3.35% for its entire system, the decline in

13 RASM is the revenue generated on each available seat mile. It is also known as unit revenue.

Figure 14: Annual US domestic average itinerary fare in constant 2016 USD


Alaska Airlines

American Airlines

Delta Air Lines

Haw aiian Airlines

United Air Lines

Allegiant Air

Envoy Air

ExpressJet Airlines

Frontier Airlines

JetBlue Airw ays

SkyWest Airlines

Southw est Airlines

Spirit Airlines

Virgin America

Netw

ork

Carr

iers

Valu

e C

arr

iers

Source: Analyst’s Composition

Figure 15: Classification of US airlines into network and value carriers


PAGE 11/32

domestic unit revenue does not seem that significant. Unit revenues were down

mainly due to weaker yields. Our analysis includes average domestic itinerary

fares that were paid at around 384 airports throughout the United States between

the third quarter of 2013 and the second quarter of 2016. These data show that

the aforementioned major 29 US airports were particularly affected by the

changing yield environment as ticket prices dropped by 4.43% during the period of

observation while the remaining 355 airports actually experienced an increase of

2.86%. In view of Delta’s strong reliance on the 29 airports it is understandable

that the company’s domestic unit revenues have been under enormous pressure.

Chicago O’Hare, Miami, Dallas, Fort Lauderdale and Houston recorded price drops

of 7% or more, whereas airports such as Baltimore, Boston, New York-JFK, San

Francisco or San Diego incurred only minor drops of up to 2% and were able to

compensate to some degree.

In the United States, Delta faces competition from two groups of carriers. The first

group consists of network carriers such as Hawaiian Airlines, Alaska Airlines,

American Airlines or United Airlines. The latter two, also referred to as legacy

carriers, show the highest resemblance with Delta Air Lines’ revenue and cost

structure or size of operations. On top of that they operate their individual route

networks via the same hub-and-spoke approach as Delta, allowing them to

efficiently serve an extensive network of airports across the country. The second

group comprises value or low-cost carriers (LCCs) such as JetBlue Airways,

Southwest Airlines or SkyWest Airlines or even ultra-low-cost carriers (ULCCs)

such as Spirit Airlines or Allegiant Air. Unlike their hub-and-spoke competitors, the

second group of carriers has chosen a point-to-point transit model through which

they serve a selective network of airports, usually limited to the most profitable

routes. By flying to secondary, less congested airports, by reducing parking time

on the ground, by employing just a few different aircraft types to lower training and

maintenance expenses and through other measures, LCCs and ULCCs are able

to substantially reduce operating expenses and undercut ticket prices of network

carriers. Figure 15 lists the group of network and value carriers that were subject

to our competitive analysis.

Our analysis of unit revenue, cost and profitability metrics reveals a significant

difference between Delta Air Lines and other US network and value carriers. In the

third quarter of 2016 our sample of network carriers averaged costs per available

seat mile (CASM)14 of 11.56 cents (2015 Q3: 11.72 cents). The average CASM for

our sample of value carriers was 9.59 cents (2015 Q3: 9.8 cents). In spite of

14 CASM is the amount of operating expenses that an airline incurred per available seat mile during a certain reporting period.

Figure 16: US airlines’ CASM 2015 Q3 vs 2016 Q3



Figure 17: US airlines’ unit fuel costs 2015 Q3 vs 2016 Q3


Figure 18: US airlines’ unit labor costs 2015 Q3 vs 2016 Q3


PAGE 12/32

network carriers’ cost reduction efforts, the unit cost gap between network and

value carriers had actually increased from 1.92 cents to 1.97 cents per available

seat mile. In both observation quarters Delta Air Lines had the highest unit costs

of our nine sample US carriers. However, it also generated the highest operating

margin in absolute and relative terms, as measured by the difference between

RASM and CASM. What is remarkable for investors is that Delta’s third quarter

margin of 30.65% exceeded the operating margins of legacy carrier rivals

American Airlines (13.51%) and United Airlines (16.35%) by far. Figure 16 to

Figure 22 provide more detail on the competitive analysis.

Outlook:

We anticipate Delta Air Lines to keep domestic capacity expansion for 2017 and

2018 in range of 2% to 4%, with the majority of this expansion coming from

mainline flights. Capacity of its regional Delta Connection partners is forecasted to

decrease further in 2017.

Latin America

As of October 2015 Latin America and the Caribbean were the smallest of the five

major world regions, with a mere 7% of the world’s capacity in ASM. Between

October 2014 and October 2015, ASMs were up 5.2% year-on-year. This was

primarily due to a 2.4% growth in departures and a 4.6% growth in average seats

per departure. The fact that over the same time interval capacity within the region

outgrew capacity to other world regions (5.8% vs 4.4%) suggests that Latin

American/Caribbean markets are far from being saturated. However, according to

demographic and economic indices the Latin American region lags behind other

parts of the world. GDP per capita growth since 2012 was only 2.2% and thus the

slowest of the five major world regions. Also compared to the almost 2,000 aircraft

that North American airlines have ordered until 2020, Latin American/Caribbean

airlines have only placed orders for 563 aircraft.

Given the local proximity of individual markets and long-term potential for air travel

from the United States to this region and vice versa, Latin America is one of the

cornerstones of Delta’s international expansion strategy, even though the current

economic uncertainties and political change in many Latin American countries

dampen expectations and create some headwind for air travel revenues.

As of October/November 2016, Delta’s entire network of 2,052 routes included 203

routes connecting Latin American/Caribbean and other domestic or international

destinations, which corresponds to roughly 10% of the entire route network.

Mainline flights to and from Latin America have contributed a little over 7% to

Delta’s total passenger revenue in the first nine months of 2016. This is roughly


Figure 19: US airlines’ other unit costs 2015 Q3 vs 2016 Q3

Figure 20: US airlines’ CASM ex 2015 Q3 vs 2016 Q3


Figure 21: US airlines’ PRASM 2015 Q3 vs 2016 Q3


Figure 22: US airlines’ operating margin 2015 Q3 vs 2016 Q3



PAGE 13/32

2% more than what had been contributed by the Latin American mainline segment

back in 2009, but slightly less than in 2015.

Since 2013 Delta Air Lines has slightly raised its capacity on mainline routes to

and from Latin American destinations from 7.75% to 9.09% of total system capacity

as recorded after the first three quarters of 2016. Regional capacity to and from

the Latin American region more than doubled since 2013, although by the end of

the third quarter of 2016 it merely represented 0.28% of total system capacity.

Mainline and regional capacity combined the Latin American region has gained

almost 2 percentage points in Delta’s total network capacity since 2013. Capacity

utilization in the mainline and regional segment has improved during the first three

quarters of 2016.

Joint ventures and equity stakes have lined up some promising growth potential

for Delta Air Lines in the Latin American region. Its equity stakes in Aeroméxico

and Gol Linhas Aéreas provide Delta with long-term income and a foothold both in

Mexico and Brazil, which the Atlanta-based carrier regards as particularly

important. Pending antitrust immunity, which was expected to be granted by the

US Department of Transportation by the end of 2016, the airline will invest another

$815 million in Aeroméxico and increase its stake to 49%. This will make Delta the

dominant foreign carrier in Mexico and bring a sizable revenue boost. Open skies

agreements between the United States and Mexico have been ratified in late

August 2016 and Delta’s US Mexico scale is expected to triple through the joint

venture. Moreover, Delta is looking into increasing its current stake of 9% in Gol

Linhas Aéreas or buying the financially struggling airline altogether, provided the

Brazilian government raises its foreign ownership limits on airlines. Despite Brazil’s

recent political and economic woes, the country is still regarded as one of Latin

America’s most vibrant regions, with the Summer Olympics in 2016 having initiated

another surge in travel demand. After 16 consecutive quarters with negative year-

on-year growth, Brazil’s unit revenues increased 30% during the third quarter of

2016. The strengthening Real has raised point-of-sale demand in Brazil.

Outlook:

Capacity in Latin America is expected to remain flat in 2017 and 2018 as Delta

aims at optimizing its unit revenues before adding further capacity to the region.

Atlantic

Between October 2014 and October 2015 European originating flights represented

23.1% of the world’s total capacity. ASMs had grown by 4.8% year-on-year, driven

by a 2.7% rise in departures and a 1.8% growth in average seats per departure

over the previous year.


PAGE 14/32

Air travel service across the Atlantic is regulated through Open Skies agreements

between the United States, Canada and the European Union, which allows airlines

to enter and exit almost every transatlantic market. On the part of the United

States, the only airlines offering transatlantic flights are the three legacy carriers

Delta Air Lines, American Airlines and United Airlines, each of which has its own

revenue sharing joint venture or strategic alliance with a European airline which

helps to efficiently operate this long-haul region. Delta collaborates with its

Skyteam partners Air France/KLM, American Airlines cooperates with its Oneworld

partner British Airways/Iberia and United Airlines has partnered up with its Star

Alliance co-member Lufthansa. Along with Air Canada, which is also part of Star

Alliance, the three US legacy carriers and their European partners offer more than

82% of daily flights across the Atlantic.

For several quarters the transatlantic region has been subject to overcapacity as

well as decreasing yields and unit revenues. In the third quarter of 2016 alone

Delta’s unit revenues declined by 9.7% year-on-year.

Between January 2016 and September 2016 the Atlantic region accounted for

slightly over 20% of Delta’s total system capacity, making the region a strategic

gateway to Europe and Africa.

This was the result of a variety of macroeconomic, sociological and competitive

forces. There has been a lot of economic uncertainty within the European Union,

ultimately depressing economic growth as well as discretionary income available

for travelling. Amongst others this was the result of aggressive capacity expansion

by Middle East carriers, the continuous emergence of new, primarily European

low-cost competitors, economic uncertainties and an overall sluggish demand in

the wake of the Brexit as well as travelers’ growing fear of terrorist attacks.

The airline industry

Five forces

In accordance with Porter’s strategic analysis framework, Delta Air Lines’ domestic

as well as international operations are subject to five forces, each of which has a

unique significance for the strategic alignment of Delta Air Lines. The five forces

are competition, industry entry and exit, availability of substitutes or complements,

supplier power and buyer power.

Competition


PAGE 15/32

Both on domestic and international routes, Delta Air Lines finds itself exposed to

significant competitive pressure, as multiple other carriers compete with a largely

undifferentiated service for the same customer base and on mostly identical

routes. In the US the Airline Deregulation Act of 1978 removed government control

over air fares, routes as well as market entry and exposed US airlines to larger

competitive constraints, which narrowed profit margins considerably.

In international markets, such as Europe, South East Asia or the Middle East, Delta

experiences similar competitive forces, although these are often times the result of

excessive government intervention. In the Gulf region, for example, the amount of

government subsidies received by carriers such as Emirates, Etihad and Qatar

Airways, makes it especially difficult for foreign carriers to compete on prices. This

is regarded as a violation of multilateral open skies agreements, which are

supposed to liberalize the regulation of international aviation, minimize this sort of

government intervention and guarantee a free-market environment.

Furthermore, the competitive landscape for Delta Air Lines is influenced by other

aspects of the airline industry, such as socioeconomic or technological dynamics.

One example is the surge of online travel agencies over the past 20 years, which

capitalized on the fact that customers became less loyal to certain airlines and that

the price elasticity of their demand for air travel increased greatly. The internet

raised transparency for travelers and enabled them to meticulously compare

prices, which needless to say intensified price competition between carriers.

Industry entry and exit

The airline industry has high entry barriers since carriers require an extensive

amount of capital to cover fixed costs from investments in aircraft, ground

equipment and other property, as well as variable costs from purchasing jet fuel,

employing staff or paying airport fees. Economies of scale, from spreading fixed

costs over a greater capacity, optimizing load factors or entering into code-sharing

agreements, provide a significant cost advantage for established carriers such as

Delta Air Lines and further strengthen barriers to enter the airline market. Another

considerable industry entry barrier is the availability of airport slots15, which are

kind of a precious commodity at certain highly congested airports and which may

be locked into long-term contracts and would have to be acquired directly from

other carriers. Hence emergent airlines are often forced to depart from and arrive

at remote airports during off-peak times.

15 A slot is the right to take off or land at a particular time.


PAGE 16/32

Exit from the airline industry is also a complicated endeavor since it requires

carriers to liquidate their tangible and intangible assets in addition to fulfilling

existing passenger reservations. The complexity of a complete industry exit drove

several major US airlines over the course of the past 15 years to enter Chapter 11

bankruptcy protection, reorganize and eventually reemerge.

Substitute and complement products or services

Instead of taking a plane, business and leisure travelers in the US can use one of

several alternative means of travel, such as train, car or bus. Given the sheer size

of the country, however, viable substitutes for long distance air travel are rather

scarce. Although the US has an interstate rail system, it lacks high-speed trains,

which makes long distance journeys via train less economical than by plane as

they take far longer. In spite of a low-fare bus transportation, Delta and other US

airlines still offer a better value for money on long-haul journeys. This is not the

case for short distances of up to 250 miles, for which trains, cars and buses are

usually the preferable means of transport not only cost-wise but also with regards

to travel time. Because of the strict security procedures at airports, people are

typically better off travelling by land for short distances. Those airlines, whose

majority of flights are short haul, are naturally at a higher risk of substitution should

they decide to increase their prices. For Delta this is only a medium threat given

the expansion of its domestic route network.

High net-worth or business customers might even substitute commercial air travel

by chartering jets, which seems more attractive in light of fractional-ownership

programs as well as a more comfortable pre-boarding and flying experience.

The continuous development of telecommunications constitutes another relevant

substitute to air travel, particularly for business travelers. Fiber optic networks and

high-speed internet allow corporations to increasingly conduct business meetings

via video conference and reduce corporate travel expenses. This is especially bad

for legacy carriers, for which first-class seating is a pivotal part of their pricing

strategy, as first-class travelers essentially overpay for the service received and

thereby boost overall passenger yields.

Complements to Delta’s service package may be of unilateral or bilateral nature.

Unilateral complements to air travel can include amenities such as wireless

internet access or duty-free shopping. Delta and other airlines offer these on-board

services in order to generate further revenue and enhance their customers’

experience, thus differentiating themselves from competitors. Unilateral

complements have the potential to affect travelers’ preference of one airline over

another, but they are unlikely to convince them to substitute away from travelling


PAGE 17/32

by land. Bilateral complements are products and services offered outside air travel.

These can be hotel stays, car rentals or other things business and leisure travelers

demand. There is a reciprocal relationship between air travel and bilateral

complements. A reduction in ticket prices is likely to stimulate air travel and

increase the demand for bilateral complements, while a drop in prices of these

travel-related goods and services can have the same effect on the demand for air

travel.

Supplier power

Delta Air Lines requires the supply of jet fuel, labor and aircraft in order to run its

business. In view of the importance of these input factors for the sake of smooth

airline operations and their share of total operating expenses, supplier power is a

significant force inside the Porter framework.

The price of kerosene is closely linked to the changes in global supply and demand

of crude oil. As a result, airlines are sensitive to the volatile price movements of

this commodity. An upwards or downwards change of one cent in the price of a

gallon of jet fuel, has an annualized impact of $40 million for Delta Air Lines. About

half of the global oil production is contributed by the Organization of the Petroleum

Exporting Countries (OPEC), giving it comprehensive power over worldwide oil

markets. In spite of the recent oversupply and the slide of crude oil prices, aircraft

fuel still represents one of the largest cost items for Delta, second only to labor

expenses. Compared to American Airlines or United Air Lines, however, Delta has

more bargaining power in the purchase of kerosene. The Atlanta-based carrier had

not only entered into numerous contracts to hedge against upwards shifts in oil

prices, but also adopted more drastic measures in 2012, when the company

purchased an old ConocoPhillips oil refinery located outside of Trainer,

Pennsylvania. Although analysts and other industry experts feared that efficiently

running a refinery would be impossible for an airline, since its core competencies

clearly lie elsewhere, Delta has managed to redeem its initial capital investment of

$150 million and be more independent from external supply of jet fuel.

The airline industry is highly labor intensive and unionized to a great extent. At the

end of 2015, about 18% of Delta’s workforce was represented by unions. These

have a considerable bargaining power, due to the fact that salaries represent about

a fourth of Delta’s total operating expenses and human capital is often seen as the

single most important key to succeeding in this business. After the company

plunged into bankruptcy in 2005, Delta’s workforce accepted huge pay cuts as a

sacrifice to initiate the turnaround and convince creditors of the viability of the new

Delta Air Lines. The record-breaking profits of the past few years, however, led


PAGE 18/32

unions to increasingly demand a fair compensation, with the Air Line Pilots

Association’s recent request for a 40% pay increase until 2018 leading the way.

Despite the significance of maintaining a sound employee morale as well as the

need to prevent major work stoppages, an excessive increase in labor costs would

constitute a big hit to Delta’s future earnings and subsequently its stock price. With

regards to labor relations, legacy carriers such as Delta Air Lines are at clear

disadvantage relative to LCCs or ULCCs which enjoyed non-unionization for years

and still pay their employees comparatively less.

Delta and its rival carriers are confronted with an even bigger supplier power when

it comes to purchasing aircraft. Boeing and Airbus virtually have a duopoly on large

aircraft. As of December 31, 2015, both manufacturers combined for roughly 78%

of Delta’s fleet, counting 809 aircraft. Boeing alone constituted a 58% share of the

total. In addition to the lack of alternative, high-end aircraft manufacturers, the sole

nature of the product gives Boeing and Airbus a favorable bargaining position.

Aircraft are no mass-produced articles, but are rather manufactured and delivered

on order, which including post-production testing can take up to three months. After

all, these are products that have to meet the latest safety standards in air travel.

The remainder of the air transport supply chain includes airports, which sell take-

off and landing slots, ticketing facilities, boarding gates and operations areas to

airlines. As the annual number of passengers travelling throughout the US and

worldwide increases, airports will continue to become more congested and put a

higher mark-up on their products and services.

Buyer power

Given the lack of differentiation between the service of two different carriers,

consumers have a significant amount of power. On top of that, buyer power is

amplified by the fact that switching costs between carriers are practically not

existent and travelers could potentially substitute away from air travel to other

means of transport. Moreover, has the abovementioned proliferation of online

travel brokers such as Expedia, or search engines, such as Skyscanner, raised

transparency for consumers and made it easier for them to compare prices, travel

duration and number of stops in order to find the best possible deal. By changing

their fee structure, Delta Air Lines and other carriers have responded to the loss of

pricing power. They reduced basic air fares and added ancillary revenues, such as

baggage fees, which was announced to help them cope with rising costs. More

obviously, though, the change in fee structure aims at making it more difficult for

customers to compare prices online and lowering the price sensitivity of discount

customers. Some airlines even advocate excluding taxes from air fares aggregated


PAGE 19/32

online, so as to enhance transparency and aggravate the consumer’s search for

the best deal even further.

Competitive analysis

SWOT analysis

Beyond Porter’s five forces framework, Delta’s competitive positioning may be

specified by contrasting strengths, weaknesses, opportunities and threats.

Strengths

Delta Air Lines continues to post strong operational metrics, leading the industry

in 2015 in terms of completion factor (99.6%), on-time rate (85.9%) and number of

days with a 100% mainline completion factor (161) and making it the best legacy

carrier by far. In only five years, Delta’s executives have managed to lead the

airline to industry-leading operational metrics, after it had been rated one of the

worst airlines in this department in 2010.

1 Strong operational metrics, eg. mainline

completion factor and on-time rate, have

improved customer satisfaction

1 International operations expose Delta to local

ups and downs of the economy and particularly

to foreign exchange volatility

2 Deleveraging has reduced risk of financial

distress, decreased interest expenses and led

to an investment grade rating by Moody's

2 Investors tend to be bearish about airlines

especially from the US

3 Solid international revenues make Delta more

stable in the event of a downturn of the US

economy

4 Excellent maintenance facilities in Atlanta allow

Delta to use older planes than competitors

5 Merger with Northwest Airlines has been

realized with very little route overlap and has

not destabilized Delta as opposed to the

mergers of American and United

6 Historic net operating losses have wiped out

Delta's tax obligations

1 Political upheaval and terrorist attacks may

cause serious damage to Delta's operations

and depress passenger demand and stock

performance

1 Strategic alliances and equity stakes in

international airlines promise further growth

potential outside a rather mature domestic

market

2 Medical hazards, such as the outbreak of

highly infectious viruses may deter travelers

from going to certain regions

3 Persistent increase of oil price to over $70 per

barrel will have a deeply adverse impact on

profits and cash flows

4 Stricter rules and regulations regarding the

training of regional airline pilots may lead to

increase in operating costs

STRENGTHS WEAKNESSES

THREATS OPPORTUNITIES


PAGE 20/32

In early February 2016 Moody’s upgraded Delta’s senior unsecured debt securities

to Baa3, rewarding the company with an investment grade rating for its ongoing

efforts to reduce net debt. Since 2009, management has slashed adjusted net debt

by $10.3 billion. At the end of 2015 adjusted net debt amounted to a total of $6.7

billion and the company plans to reduce this number even further to $4 billion by

2020. The true value of reduced leverage and lower interest expenses will start to

reveal itself once industry fundamentals, such as crude oil prices or interest rates,

start to worsen as it puts Delta in more control of an industry downturn.

Another strength is the solid international revenue base of Delta Air Lines, which

makes it less prone to economic downturns of the US market and receding

consumer discretionary spending. In 2015 Delta generated approximately 32% of

its total passenger revenue of $34.78 billion in foreign markets, with the Latin

American region contributing 7%, the transatlantic region contributing 16% and the

Pacific region contributing another 9%.

Delta has a strongly ROIC focused approach in managing its aircraft fleet. While

American Airlines and United Air Lines have greatly modernized their fleets, Delta

Air Lines has learnt from its pre-bankruptcy mistakes and spent considerably less

on new aircraft. Delta’s cost advantage is amplified by the fact that, in spite of its

fleet being on average older than American’s or United’s, it actually has a lower

unit maintenance cost than the two rival legacy carriers. Also its mainline

completion and on-time arrival results are better, which suggests Delta knows how

to utilize its older aircraft efficiently and that its maintenance and repair facilities

are performing well. Although new aircraft, such as the Boeing 787 Dreamliner, are

known to be more fuel efficient than old models, Delta’s choice of older planes has

saved a lot of capital expenditures. It also speaks for Delta’s economic sense that

they purchase older planes which are less expensive.

Compared to its legacy carrier rivals American Airlines and United Air Lines, Delta

has fully realized its cost and revenue synergies from merging with Northwest

Airlines. The 2008 merger has combined Northwest’s presence in Asia with Delta’s

strong performance in Latin America and Europe. While Delta’s merger integration

risk is retired, United is still wrapping up the merger with Continental and lags Delta

in terms of operating margin. American is still highly leveraged after merging with

US Airways in 2013.

Weaknesses

Delta’s revenue diversification is not only a strength but also a weakness, as it

exposes the airline to international economic ups and downs and especially to the

volatility of foreign exchange markets. In 2015, the strong appreciation of the US


PAGE 21/32

dollar against several other currencies, that Delta had economic exposure in,

created major headwinds as it lowered non-US dollar earnings after translating

them back into US dollar. In the fourth quarter of 2015 alone, the headwind

accounted for $160 million in loss of revenue.

In light of the company’s bankruptcy in 2005 as well as the general airline industry’s

longstanding plight, investors are still highly pessimistic on Delta’s stock. That

being said, a lot of issues, such as capacity growth, fuel prices or union demands

make airline stocks in general a lot riskier than other stocks. Like its network carrier

rivals, Delta Air Lines is strongly undervalued compared to average industrials or

transportation stocks and remains haunted by the past industry mistakes.

Opportunities

Joint ventures and equity stakes have lined up some promising international

growth potential for Delta Air Lines. Equity stakes in airlines, such as Aeroméxico,

China Easter, GOL or Virgin Atlantic, provide Delta with long-term income and a

foothold in regions, which the Atlanta-based carrier regards as strategically

important. Furthermore, these investments diversify Delta’s financial exposure to

different regions and currencies. Further joint ventures with China Eastern (3%),

Virgin Atlantic (49%) or Air France/KLM have firmly established Delta Air Lines on

Atlantic and Pacific routes, without incurring the expenses of organic expansion.

Threats

Political upheaval as well as terrorist attacks have the potential to do serious

damage to Delta’s operations as the carrier may temporarily need to cancel flights

to certain affected regions, as experienced in the case of Brussels, or travelers

may switch to other means of transport as they lose confidence in the safety of air

travel. The spreading of ISIS and other extremist groups will continue to pose a big

threat.

The outbreak of highly infectious viruses, such as Ebola or Zika, can negatively

impact Delta’s operations as travelers may deter from going to certain regions.

However, these medical risks may rather shift leisure travel to other regions or

markets than end it completely.

Since reaching its 2016 low of $27.88 on January 20, the price per barrel of Brent

crude oil has increased by almost $20. West Texas Intermediate has gained over

$17 since hitting rock bottom of $26.21 per barrel on February 11. Even though

crude oil prices are still comfortably low, compared to where they were in the

summer of 2014, a persistent price increase reduces Delta’s operating profits and

cash flows. The recent rally in oil prices has been triggered due to the fact that


PAGE 22/32

China increased its crude oil imports, OPEC is negotiating an output freeze and

also the US crude oil production in major shale regions has dropped.

Stricter rules and regulations regarding minimum training hours as well as deeper

labor issues on working hours, compensation and retirement led to massive pilot

dropouts at regional airlines, which adversely affects not only their own operating

costs, but also represents a big threat to larger carriers, such as Delta Air Lines.

Delta depends on mid-sized carriers to serve rural passengers and feed them into

their network.

Risks to the investment thesis

Investing in Delta Air Lines is subject to a variety of company internal risks as well

as external risks linked to the airline industry or other macroeconomic variables.

External risks

A major source of risk for the entire airline sector is the cost of crude oil and thus

the price for aircraft fuel. While fuel prices have remained relatively flat during the

1990s, they experienced a steep rise from the beginning of the new millennium

onwards until they peaked in the first half of 2012. Since then they gradually

declined to lower levels. The volatile nature of oil prices and the fact that aircraft

fuel expenses represent a material cost component for every carrier, put operating

results at substantial risk. Even though most airlines hedge against a future

upwards shift in the oil price, sudden price jumps can still severely impair the

operating business of airlines as they may not be fully able to pass along higher

fuel costs to customers, particularly those that purchased their tickets well in

advance.

Not only since the events of September 11, 2001, have geopolitical conflicts and

potential terrorist attacks posed a significant threat to the demand for air travel

across the globe and reinforced the necessity to implement stricter security

measures at airports and airlines alike. As a consequence, the operating business

of many airlines has been adversely affected by sharp increases in security costs

and selective, yet mostly temporary decreases in revenues. The attacks witnessed

in Paris, Istanbul and Brussels in late 2015 and early 2016 respectively,

demonstrate the still omnipresent threat of terrorist activities to the aviation industry

in general.

The massive outbreak of Ebola across Northern African states or the Zika virus in

South America have cast light on the ways in which contagious illnesses may lower


PAGE 23/32

the willingness to travel to certain regions of the earth and travel restrictions can

adversely impact airlines’ operating results.

Internal risks

Unlike American Airlines, Delta Air Lines has been hedging the upside of oil price

movements. Although these hedging activities aim at reducing the risk of adverse

oil price movements, the mere rebalancing or mark-to-market adjustments of the

hedge portfolio may require Delta to post a significant amount of margin on short

notice and heavily dip into its cash holdings.

The main purposes of Delta’s non-controlling investments in as well as its joint

ventures and strategic alliances with other airlines, are to broaden the global

network, achieve revenue or cost synergies and to make a reasonable return on

investment. However, these commercial relationships expose Delta Air Lines to

potentially improper business behavior or non-compliance with laws and

regulations by their partners and any service disruptions or reputational damages

associated with it.

The solvency of Delta Air Lines relies on the continuous guarantee of credit

facilities which require the company to hold a certain amount of liquidity or post

collateral against the risk of default. A rapid decline in the value of collateral could

adversely affect Delta’s credit rating across global equity and debt markets, lead

to the reevaluation or even cancellation of credit agreements and accelerate a

possible default.

As for any other labor intensive business, labor disputes or even strikes of certain

employee groups may seriously disrupt operations and bring about financial losses

for Delta Air Lines. The fact that approximately 18% of Delta’s staff was unionized

at the end of 2015 underlines the great risk involved in labor relations. Another

labor-related risk is the turnover of senior management or crucial members of staff

without finding adequate replacements which may impact business in the short,

medium and long run.

A key risk in Delta’s operations is also the strong dependence on major domestic

and international airports. These hubs not only guarantee the majority of non-stop

flights but are also vital in the distribution of transit passengers travelling to and

from major cities in the US and abroad. In the case of a service interruption at the

Hartsfield-Jackson airport in Atlanta or one of Delta’s smaller hubs, its business

would be immensely impaired. Any stoppage in services provided by third-party

regional carriers may have a similarly negative effect on Delta’s operating results

as it may represent a sizable loss of capacity and translate into reduced sales and

possibly remediating expenses.


PAGE 24/32

Financial outlook

Dividend policy

As Delta’s management repeatedly said in the past, the company will stick to its

strategy of returning large amounts of cash to shareholders. In May 2015,

management announced to return $6 billion in cash to shareholders until end of

2017. Legacy carriers such as Delta, American or United have had a long history

of not paying any dividends at all, until Delta reinstated its dividend in 2013,

followed suit by American in 2014. Unlike American, however, Delta did not keep

its dividend constant but increased it from a quarterly 3 cents in 2013, to 7.5 cents

in 2014 and 11.25 cents in 2015. In expectation of lower-for-longer oil prices, solid

earnings, decreasing debt levels and strong cash flows, I forecast Delta to further

boost its quarterly dividend, although more conservatively than in the last two

years, and endeavour to portray itself as a dividend growth stock.

Beyond increasing its dividends, the Atlanta-based carrier will continue to buy back

shares on a massive scale. Of the $6 billion in cash, which shareholders were

promised until the end of 2017, Delta plans to buy back equity in the amount of $5

billion. Since introducing dividend payments in 2013, Delta has reduced its

outstanding shares from 856.6 million to 736.4 million at the end of 2016. Share

buybacks have three major advantages over dividends. First of all, by reducing

outstanding shares they raise the dividend per share without actually increasing

total dividend distribution. Second of all, they continue to be a cheap form of

shareholder compensation while the stock trades at such a large discount to

average industrials or transport stocks. Third of all, they leave Delta more room for

manoeuver than committing to a fixed dividend payment.

Valuation

Delta Air Lines is projected to change its debt-to-equity ratio to 22% until 2025.

Since the leverage of Delta, American and United differs greatly from the leverage

of LCCs, it does not make sense to include the latter in the target capital ratio.

Based on this assumption, the WACC approach will value Delta’s free cash flows

until perpetuity.

WACC approach

Figure 23: Daily Yields 30 Year US T-Bonds


PAGE 25/32

The underlying valuation model assumes Delta Air Lines is part of a group of

industry peers, composed of both legacy carriers and LCCs. Although the LCCs in

the peer group16 have a different capital structure, their systematic risk is

comparable to that of legacy carriers. The cost of equity is calculated through

application of the CAPM. I assume the risk free rate to correspond to the yield on

30-year US Treasury bonds, which as of December 30, 2016 was 3.06%. Figure

23 highlights 30-year US T-Bond yields since May 2011. The market risk premium

is set at 5%.

Multiples

We considered several different ratios for a multiples valuation of Delta Air Lines

and found the company to be largely undervalued compared to most of its domestic

as well as international competitors. Figure 24 collates Delta’s enterprise value

multiples with the arithmetic average of sample US network and value carriers

mentioned before. Our analysis suggests that Delta is trading at a 6.83% discount

(EV/EBITDA) respectively a 20.39% discount (EV/Revenue) to its industry peers.

An even more precise valuation is provided in Figure 25 which compares Delta’s

price earnings multiples with the averages of domestic as well as international

airlines. According to forward price earnings ratios, Delta Air Lines is undervalued

by 24.42% against domestic peers and 40.61% against a sample of international

carriers, mostly from Asia.

The systematic undervaluation across different financial metrics substantiates

investors’ generally pessimistic perception of Delta. Effectively the market is

questioning Delta’s capability to continue to post the level of operating margins that

it has for the last two years from 2017 onwards.

16 The LCCs analyzed are Southwest Airlines, JetBlue Airways, SkyWest, Alaska Air Group, Hawaiian Holdings and Spirit Airlines.

Figure 24: Enterprise Value multiples Delta vs competitors

Source: Yahoo Finance

Figure 25: P/E multiples Delta vs competitors

Source: Morningstar

Source: US Department of the Treasury


PAGE 26/32

Appendix

Appendix 1 – Audited (A) and Forecasted (F) traffic, capacity and

passenger load factors by regions

Domestic 2014A 2015A 2016F 2017F 2018F 2019F 2020F 2021F 2022F 2023F 2024F 2025F

Traffic (RPM m)

Domestic 120,211 126,298 130,780 133,428 138,972 143,250 147,660 152,206 155,250 158,355 161,523 164,753

Domestic Mainline 98,844 105,455 109,949 112,716 117,224 120,741 124,363 128,094 130,656 133,269 135,935 138,653

Domestic Regional 21,367 20,843 20,832 20,712 21,748 22,509 23,297 24,112 24,594 25,086 25,588 26,100

Total System 202,925 209,625 213,089 214,639 219,234 223,173 227,769 232,512 236,398 240,357 244,389 248,496

Domestic 59.24% 60.25% 61.37% 62.16% 63.39% 64.19% 64.83% 65.46% 65.67% 65.88% 66.09% 66.30%

Domestic Mainline 48.71% 50.31% 51.60% 52.51% 53.47% 54.10% 54.60% 55.09% 55.27% 55.45% 55.62% 55.80%

Domestic Regional 10.53% 9.94% 9.78% 9.65% 9.92% 10.09% 10.23% 10.37% 10.40% 10.44% 10.47% 10.50%

Total System 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%

Capacity (ASM m)

Domestic 141,128 146,899 153,338 156,394 162,908 167,930 173,108 178,446 182,015 185,656 189,369 193,156

Domestic Mainline 114,180 121,095 127,433 130,619 135,844 139,919 144,117 148,440 151,409 154,437 157,526 160,676

Domestic Regional 26,948 25,804 25,905 25,775 27,064 28,011 28,992 30,006 30,606 31,218 31,843 32,480

Total System 239,676 246,764 251,856 253,756 259,157 263,790 269,176 274,737 279,314 283,976 288,725 293,562

Domestic 58.88% 59.53% 60.88% 61.63% 62.86% 63.66% 64.31% 64.95% 65.17% 65.38% 65.59% 65.80%



Total System 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%

Load Factor

Domestic 85.18% 85.98% 85.29% 85.32% 85.31% 85.30% 85.30% 85.30% 85.30% 85.30% 85.30% 85.30%



Total System 84.67% 84.95% 84.61% 84.58% 84.60% 84.60% 84.62% 84.63% 84.64% 84.64% 84.64% 84.65%

Latin America 2014A 2015A 2016F 2017F 2018F 2019F 2020F 2021F 2022F 2023F 2024F 2025F

Traffic (RPM m)

Latin America 18,062 19,004 19,778 19,964 20,472 20,742 21,021 21,310 21,459 21,612 21,768 21,927

Latin America Mainline 17,690 18,587 19,232 19,361 19,748 19,945 20,145 20,346 20,448 20,550 20,653 20,756

Latin America Regional 372 417 546 603 724 796 876 963 1,011 1,062 1,115 1,171

Total System 202,925 209,625 213,089 214,639 219,234 223,173 227,769 232,512 236,398 240,357 244,389 248,496

Latin America 8.90% 9.07% 9.28% 9.30% 9.34% 9.29% 9.23% 9.16% 9.08% 8.99% 8.91% 8.82%

Latin America Mainline 8.72% 8.87% 9.03% 9.02% 9.01% 8.94% 8.84% 8.75% 8.65% 8.55% 8.45% 8.35%

Latin America Regional 0.18% 0.20% 0.26% 0.28% 0.33% 0.36% 0.38% 0.41% 0.43% 0.44% 0.46% 0.47%

Total System 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%

Capacity (ASM m)

Latin America 21,725 22,966 23,297 23,547 24,154 24,477 24,812 25,159 25,340 25,524 25,711 25,903

Latin America Mainline 21,230 22,435 22,608 22,789 23,244 23,477 23,712 23,949 24,068 24,189 24,310 24,431

Latin America Regional 496 531 689 758 910 1,001 1,101 1,211 1,271 1,335 1,402 1,472

Total System 239,676 246,764 251,856 253,756 259,157 263,790 269,176 274,737 279,314 283,976 288,725 293,562

Latin America 9.06% 9.31% 9.25% 9.28% 9.32% 9.28% 9.22% 9.16% 9.07% 8.99% 8.91% 8.82%



Total System 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%

Load Factor

Latin America 83.14% 82.75% 84.89% 84.78% 84.75% 84.74% 84.72% 84.70% 84.69% 84.68% 84.66% 84.65%



Total System 84.67% 84.95% 84.61% 84.58% 84.60% 84.60% 84.62% 84.63% 84.64% 84.64% 84.64% 84.65%

Atlantic 2014A 2015A 2016F 2017F 2018F 2019F 2020F 2021F 2022F 2023F 2024F 2025F

Traffic (RPM m)

Atlantic 40,205 40,437 39,748 39,735 39,139 38,943 38,749 38,555 38,940 39,330 39,723 40,120

Total System 202,925 209,625 213,089 214,639 219,234 223,173 227,769 232,512 236,398 240,357 244,389 248,496

Atlantic 19.81% 19.29% 18.65% 18.51% 17.85% 17.45% 17.01% 16.58% 16.47% 16.36% 16.25% 16.15%

Total System 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%

Capacity (ASM m)

Atlantic 47,566 49,096 49,249 49,298 48,559 48,316 48,074 47,834 48,312 48,796 49,284 49,776

Total System 239,676 246,764 251,856 253,756 259,157 263,790 269,176 274,737 279,314 283,976 288,725 293,562

Atlantic 19.85% 19.90% 19.55% 19.43% 18.74% 18.32% 17.86% 17.41% 17.30% 17.18% 17.07% 16.96%

Total System 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%

Load Factor

Atlantic 84.52% 82.36% 80.71% 80.60% 80.60% 80.60% 80.60% 80.60% 80.60% 80.60% 80.60% 80.60%

Total System 84.67% 84.95% 84.61% 84.58% 84.60% 84.60% 84.62% 84.63% 84.64% 84.64% 84.64% 84.65%


PAGE 27/32

Appendix 2 – WACC Delta Air Lines

Pacific 2014A 2015A 2016F 2017F 2018F 2019F 2020F 2021F 2022F 2023F 2024F 2025F

Traffic (RPM m)

Pacific 24,448 23,886 22,782 21,512 20,652 20,239 20,340 20,442 20,748 21,059 21,375 21,696

Total System 202,925 209,625 213,089 214,639 219,234 223,173 227,769 232,512 236,398 240,357 244,389 248,496

Pacific 12.05% 11.39% 10.69% 10.02% 9.42% 9.07% 8.93% 8.79% 8.78% 8.76% 8.75% 8.73%

Total System 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%

Capacity (ASM m)

Pacific 29,257 27,803 25,972 24,517 23,537 23,066 23,181 23,297 23,647 24,001 24,361 24,727

Total System 239,676 246,764 251,856 253,756 259,157 263,790 269,176 274,737 279,314 283,976 288,725 293,562

Pacific 12.21% 11.27% 10.31% 9.66% 9.08% 8.74% 8.61% 8.48% 8.47% 8.45% 8.44% 8.42%

Total System 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%

Load Factor

Pacific 83.56% 85.91% 87.72% 87.74% 87.74% 87.74% 87.74% 87.74% 87.74% 87.74% 87.74% 87.74%

Total System 84.67% 84.95% 84.61% 84.58% 84.60% 84.60% 84.62% 84.63% 84.64% 84.64% 84.64% 84.65%

Unlevered beta - Delta Air Lines 1.17

Unlevered beta - Industry 1.12

US corporate income tax rate 35.00%

Equity 36.10

Debt 7.57

Current equity ratio 82.67%

Current debt ratio 17.33%

Target D/E 75.00%

Levered beta - Industry 1.66

Cost of equity

US risk free rate 3.06%

Market risk premium 5.00%

Cost of equity 11.37%

Cost of debt

Alternative 1

Moody's credit rating Baa1

US risk free rate 3.06%

Debt Beta 0.10

Market risk premium 5.00%

Cost of debt - Alternative 1 3.56%

Alternative 2

Yield to Maturity 6.06%

Probability of Default 0.00%

Loss Given Default 46.59%

Cost of debt - Alternative 2 6.06%

Weighted Average Cost of Capital

Alternative 1

Target equity ratio 57.14%

Target debt ratio 42.86%

WACC - Alternative 1 7.49%

Alternative 2

Target equity ratio 57.14%

Target debt ratio 42.86%

WACC - Alternative 2 8.19%

Terminal value

Nominal constant growth of FCF 2.00%

Adjusted WACC 6.06%

WACC Delta Air Lines


PAGE 28/32

Appendix 3 – Income Statement 2015-2025 (in million USD)

INCOME STATEMENT

in USD mn (if not stated differently) 2015A 2016F 2017F 2018F 2019F 2020F 2021F 2022F 2023F 2024F 2025F

Mainline 28,898 28,912 29,015 29,397 29,927 30,530 31,147 32,073 33,027 34,010 35,022

Regional carriers 5,884 5,793 5,751 6,033 6,288 6,555 6,834 7,153 7,487 7,837 8,204

Total passenger revenue 34,782 34,705 34,767 35,430 36,215 37,085 37,981 39,226 40,514 41,847 43,226

Cargo 813 740 714 689 686 682 679 685 692 699 706

Other 5,109 5,416 5,849 6,317 6,948 7,643 8,408 9,416 10,546 11,812 13,229

Total operating revenue 40,704 40,861 41,329 42,436 43,849 45,410 47,067 49,328 51,753 54,358 57,162

Aircraft fuel and related taxes -6,544 -5,054 -6,536 -6,873 -7,458 -8,088 -8,575 -9,052 -9,552 -9,699 -9,861

Salaries and related costs -8,776 -9,154 -9,293 -9,728 -9,937 -10,343 -10,768 -10,935 -11,284 -11,645 -12,018

Regional carrier expense -4,241 -4,229 -4,371 -4,585 -4,968 -5,178 -5,399 -5,723 -5,990 -6,270 -6,563

Aircraft maintenance materials and outside repairs -1,848 -1,922 -1,989 -2,059 -2,110 -2,163 -2,217 -2,261 -2,307 -2,353 -2,400

Depreciation and amortization -1,835 -1,769 -1,880 -2,020 -2,076 -2,189 -2,335 -2,423 -2,611 -2,815 -3,037

Contracted services -1,848 -1,924 -1,955 -2,042 -2,121 -2,214 -2,312 -2,399 -2,489 -2,582 -2,680

Passenger commissions and other selling expenses -1,672 -1,727 -1,755 -1,838 -1,920 -2,019 -2,124 -2,220 -2,320 -2,425 -2,535

Landing fees and other rents -1,493 -1,536 -1,554 -1,603 -1,652 -1,709 -1,769 -1,828 -1,889 -1,952 -2,018

Profit sharing -1,490 -1,042 -1,176 -994 -946 -777 -757 -755 -830 -892 -1,002

Passenger service -872 -924 -971 -1,019 -1,060 -1,102 -1,146 -1,186 -1,228 -1,271 -1,315

Aircraft rent -250 -253 -256 -260 -265 -271 -276 -283 -290 -297 -305

Restructuring and other items -35 -300 -250 -250 -230 -230 -230 -200 -200 -200 -200

Other -1,998 -2,058 -2,130 -2,205 -2,293 -2,384 -2,480 -2,591 -2,708 -2,830 -2,957

Total operating expense -32,902 -31,892 -34,115 -35,476 -37,035 -38,668 -40,388 -41,856 -43,698 -45,232 -46,891

Operating income 7,802 8,969 7,214 6,960 6,813 6,742 6,679 7,472 8,056 9,126 10,271

Interest expense, net -481 -484 -315 -277 -173 -135 -71 -82 -112 -152 -211

Amortization of debt discount, net 0 0 0 0 0 0 0 0 0 0 0

Loss on extinguishment of debt 0 0 0 0 0 0 0 0 0 0 0

Miscellaneous, net -164 -30 -40 -40 -45 -45 -45 -50 -50 -50 -50

Total non-operating expense, net -645 -514 -355 -317 -218 -180 -116 -132 -162 -202 -261

Income before income taxes 7,157 8,455 6,859 6,643 6,595 6,562 6,564 7,340 7,894 8,924 10,009

Income tax (provision) benefit -2,631 -3,111 -2,524 -2,444 -2,427 -2,415 -2,415 -2,701 -2,905 -3,284 -3,683

Net income 4,526 5,343 4,335 4,198 4,168 4,147 4,148 4,639 4,989 5,640 6,326

Basic earnings per share 5.68 7.26 6.01 5.91 5.92 5.92 5.95 6.66 7.16 8.10 9.08

Diluted earnings per share 5.63 7.19 5.95 5.85 5.86 5.86 5.89 6.59 7.09 8.01 8.99

Cash dividends declared per share 0.45 1.09 1.20 1.18 1.78 2.07 2.38 2.66 2.86 4.05 4.54


PAGE 29/32

Appendix 4 – Balance Sheet 2015-2025 (in million USD)

BALANCE SHEET

in USD mn (if not stated differently) 2015A 2016F 2017F 2018F 2019F 2020F 2021F 2022F 2023F 2024F 2025F

Assets

Cash and cash equivalents 1,972 3,751 3,658 4,494 4,994 5,947 5,895 5,615 5,204 4,498 4,009

Short-term investments 1,465 1,516 1,585 1,656 1,739 1,826 1,917 2,022 2,133 2,251 2,375

Restricted cash, cash equivalents and short-term investments 0 0 0 0 0 0 0 0 0 0 0

Accounts receivable, net of an allowance for uncollectible accounts 2,020 2,127 2,208 2,267 2,403 2,488 2,579 2,770 2,907 3,053 3,210

Hedge margin receivable 119 60 33 18 13 9 6 5 4 3 3

Fuel inventory 379 261 316 332 356 386 409 423 446 453 461

Expendable parts and supplies inventory, net of an allowance for obsolescence318 289 295 306 303 316 330 332 346 356 368

Hedge derivatives asset 1,987 1,391 1,043 782 626 501 401 340 289 246 209

Deferred income taxes, net 0 0 0 0 0 0 0 0 0 0 0

Prepaid expenses and other current assets 796 812 824 836 847 858 870 878 887 896 905

Total current assets 9,056 10,206 9,962 10,692 11,280 12,331 12,406 12,386 12,217 11,756 11,539

Property and equipment 33,910 36,405 39,671 42,631 44,954 47,418 50,563 53,895 58,079 62,620 67,548

less: accumulated depreciation and amortization -10,871 -12,327 -13,874 -15,537 -17,245 -19,047 -20,969 -22,963 -25,112 -27,428 -29,928

Property and equipment, net of accumulated depreciation and amortization23,039 24,078 25,796 27,094 27,709 28,371 29,594 30,932 32,967 35,191 37,621

Goodwill 9,794 9,794 9,794 9,794 9,794 9,794 9,794 9,794 9,794 9,794 9,794

Identifiable intangibles, net of accumulated amortization 4,861 4,873 4,883 4,893 4,900 4,907 4,915 4,920 4,925 4,929 4,934

Deferred income taxes, net 4,956 4,900 4,900 4,500 4,500 4,000 4,000 4,000 4,000 4,000 4,000

Other noncurrent assets 1,428 1,499 1,559 1,622 1,670 1,721 1,772 1,808 1,844 1,881 1,918

Total noncurrent assets 21,039 21,067 21,136 20,808 20,864 20,422 20,481 20,521 20,562 20,604 20,647

Total assets 53,134 55,350 56,895 58,594 59,854 61,124 62,481 63,840 65,746 67,552 69,806

Liabilities and stockholders' equity

Current maturities of long-term debt and capital leases 1,563 1,751 1,961 2,157 2,372 2,610 2,818 3,044 3,287 3,550 3,834

Air traffic liability 4,503 4,548 4,582 4,617 4,640 4,663 4,686 4,703 4,719 4,735 4,752

Accounts payable 2,743 2,621 2,710 2,819 2,841 2,966 3,098 2,982 3,113 3,222 3,340

Accrued salaries and related benefits 3,195 3,035 2,914 2,797 2,713 2,632 2,553 2,502 2,452 2,403 2,355

Hedge derivatives liability 2,581 1,936 1,549 1,239 1,053 895 761 685 616 555 499

Frequent flyer deferred revenue 1,635 1,651 1,664 1,676 1,686 1,696 1,707 1,715 1,724 1,732 1,741

Taxes payable 0 0 0 0 0 0 0 0 0 0 0

Fuel card obligation 0 0 0 0 0 0 0 0 0 0 0

Other accrued liabilities 1,306 1,371 1,426 1,483 1,528 1,574 1,621 1,653 1,686 1,720 1,754

Total current liabilities 17,526 16,913 16,806 16,787 16,833 17,036 17,244 17,283 17,597 17,918 18,276

Long-term debt and capital leases 6,766 5,751 4,888 4,155 3,823 3,517 3,447 3,378 3,310 3,244 3,179

Pension, postretirement and related benefits 13,855 12,960 11,839 10,759 9,248 7,785 6,372 4,871 3,431 2,054 742

Frequent flyer deferred revenue 2,246 2,358 2,453 2,551 2,627 2,706 2,787 2,843 2,900 2,958 3,017

Deferred income taxes, net 0 128 171 202 237 280 331 392 467 556 662

Other noncurrent liabilities 1,891 1,929 1,958 1,987 2,007 2,027 2,047 2,058 2,068 2,078 2,089

Total noncurrent liabilities 24,758 23,126 21,308 19,654 17,943 16,315 14,985 13,542 12,175 10,889 9,689

Total liabilities 42,284 40,039 38,114 36,441 34,776 33,351 32,228 30,825 29,772 28,807 27,965

Common stock, at $0.0001 par value 0 0 0 0 0 0 0 0 0 0 0

Additional paid-in capital 10,875 10,857 10,927 11,014 11,102 11,191 11,279 11,368 11,456 11,544 11,632

Retained earnings (accumulated deficit) 7,623 12,165 15,633 18,991 21,909 24,604 27,093 29,877 32,870 35,690 38,853

Accumulated other comprehensive loss -7,275 -7,275 -7,275 -7,275 -7,275 -7,275 -7,275 -7,275 -7,275 -7,275 -7,275

Treasury stock, at cost -373 -436 -504 -578 -658 -747 -845 -955 -1,077 -1,215 -1,369

Total stockholders' equity 10,850 15,311 18,781 22,153 25,078 27,773 30,253 33,015 35,974 38,745 41,841

Total liabilities and stockholders' equity 53,134 55,350 56,895 58,594 59,854 61,124 62,481 63,840 65,746 67,552 69,806


PAGE 30/32

Appendix 5 – DCF Valuation Model

2016F 2017F 2018F 2019F 2020F 2021F 2022F 2023F 2024F 2025F

NOPLAT 5,016 4,905 4,504 4,640 4,307 4,571 5,063 5,445 6,135 6,873

+ Depreciation and amortization 1,769 1,880 2,020 2,076 2,189 2,335 2,423 2,611 2,815 3,037

= Gross cash flow 6,785 6,785 6,524 6,715 6,497 6,906 7,486 8,056 8,950 9,910

+ Investments in invested capital -2,875 -3,640 -3,288 -2,830 -2,858 -3,553 -4,107 -4,712 -5,118 -5,551

= Operating free cash flow 3,910 3,145 3,236 3,886 3,639 3,353 3,379 3,344 3,832 4,358

Net change in equity -882 -865 -827 -1,243 -1,452 -1,668 -1,877 -2,030 -2,869 -3,229

Income tax rate 35.00% 35.00% 35.00% 35.00% 35.00% 35.00% 35.00% 35.00% 35.00% 35.00%

Debt / Enterprise Value (@ market) 43% 43% 43% 43% 43% 43% 43% 43% 43% 43%

Equity / Enterprise Value (@ market) 57% 57% 57% 57% 57% 57% 57% 57% 57% 57%

Cost of Debt 6.06% 6.06% 6.06% 6.06% 6.06% 6.06% 6.06% 6.06% 6.06% 6.06%

Cost of Equity 11.37% 11.37% 11.37% 11.37% 11.37% 11.37% 11.37% 11.37% 11.37% 11.37%

WACC 8.19% 8.19% 8.19% 8.19% 8.19% 8.19% 8.19% 8.19% 8.19% 8.19%

FCF growth rate -14.97% -19.57% 2.91% 20.06% -6.35% -7.86% 0.79% -1.04% 14.59% 13.74%

FCF growth rate in perpetuity 2.00%

Enterprise Value 57,284 58,828 60,407 61,466 62,859 64,651 66,564 68,669 70,458 71,867

+ Excess cash 2,934 2,832 3,645 4,117 5,039 4,954 4,628 4,169 3,411 2,866

+ Short-term investments 1,516 1,585 1,656 1,739 1,826 1,917 2,022 2,133 2,251 2,375

+ Restricted cash, cash equivalents and short-term investments0 0 0 0 0 0 0 0 0 0

- Current maturities of long-term debt and capital leases1,751 1,961 2,157 2,372 2,610 2,818 3,044 3,287 3,550 3,834

- Long-term debt and capital leases 5,751 4,888 4,155 3,823 3,517 3,447 3,378 3,310 3,244 3,179

- Pension, postretirement and related benefits 12,960 11,839 10,759 9,248 7,785 6,372 4,871 3,431 2,054 742

= Equity Value 41,272 44,556 48,637 51,878 55,811 58,885 61,922 64,943 67,272 69,352

Outstanding shares 736 722 711 704 700 697 697 697 697 697

Current share price (Dec 30, 2016) 49.19

Expected share price 56.05 61.74 68.42 73.72 79.71 84.52 88.88 93.21 96.56 99.54

Expected capital gain 25.52% 39.10% 49.87% 62.04% 71.82% 80.68% 89.50% 96.30% 102.36%

Shareholders' cash in / cash out (per share) -1.20 -1.20 -1.16 -1.77 -2.07 -2.39 -2.69 -2.91 -4.12 -4.63

Expected cash gain -2.44% -2.36% -3.59% -4.21% -4.87% -5.48% -5.92% -8.37% -9.42%

Total shareholders' expected return 23.08% 36.74% 46.28% 57.82% 66.95% 75.21% 83.58% 87.92% 92.94%

True Recommendation BUY BUY BUY BUY BUY BUY BUY BUY BUY

Recommendation (research notes) BUY BUY BUY BUY BUY BUY BUY BUY BUY


PAGE 31/32

Appendix 6 – Sensitivity Analyses

1.41 1.46 1.51 1.56 1.61 1.66 1.71 1.76 1.81 1.86 1.91

1.81% 87.06 83.86 80.84 77.99 75.30 72.74 70.31 68.01 65.82 63.73 61.74

2.06% 83.86 80.84 77.99 75.30 72.74 70.31 68.01 65.82 63.73 61.74 59.84

2.31% 80.84 77.99 75.30 72.74 70.31 68.01 65.82 63.73 61.74 59.84 58.03

2.56% 77.99 75.30 72.74 70.31 68.01 65.82 63.73 61.74 59.84 58.03 56.29

2.81% 75.30 72.74 70.31 68.01 65.82 63.73 61.74 59.84 58.03 56.29 54.63

3.06% 72.74 70.31 68.01 65.82 63.73 61.74 59.84 58.03 56.29 54.63 53.04

3.31% 70.31 68.01 65.82 63.73 61.74 59.84 58.03 56.29 54.63 53.04 51.51

3.56% 68.01 65.82 63.73 61.74 59.84 58.03 56.29 54.63 53.04 51.51 50.05

3.81% 65.82 63.73 61.74 59.84 58.03 56.29 54.63 53.04 51.51 50.05 48.64

4.06% 63.73 61.74 59.84 58.03 56.29 54.63 53.04 51.51 50.05 48.64 47.28

4.31% 61.74 59.84 58.03 56.29 54.63 53.04 51.51 50.05 48.64 47.28 45.98

US

ris

k fre

e r

ate

Levered industry betaRun

3.75% 4.00% 4.25% 4.50% 4.75% 5.00% 5.25% 5.50% 5.75% 6.00% 6.25%

0.75% 60.56 58.66 56.90 55.25 53.72 52.28 50.93 49.66 48.47 47.34 46.28

1.00% 62.86 60.80 58.89 57.11 55.45 53.91 52.46 51.10 49.83 48.63 47.50

1.25% 65.36 63.11 61.03 59.11 57.32 55.66 54.10 52.64 51.28 50.00 48.79

1.50% 68.08 65.62 63.36 61.27 59.33 57.53 55.86 54.29 52.83 51.46 50.17

1.75% 71.06 68.36 65.89 63.61 61.50 59.56 57.75 56.06 54.49 53.01 51.63

2.00% 74.34 71.37 68.65 66.15 63.86 61.74 59.78 57.96 56.26 54.68 53.20

2.25% 77.97 74.67 71.67 68.93 66.42 64.11 61.98 60.01 58.17 56.47 54.87

2.50% 82.00 78.32 75.00 71.98 69.22 66.69 64.37 62.22 60.23 58.39 56.67

2.75% 86.50 82.39 78.68 75.33 72.29 69.51 66.96 64.62 62.46 60.46 58.60

3.00% 91.57 86.93 82.77 79.04 75.66 72.60 69.80 67.23 64.88 62.70 60.69

3.25% 97.32 92.04 87.35 83.16 79.40 76.00 72.91 70.09 67.51 65.13 62.94

Market risk premium

TV

gro

wth

Run

3.75% 4.00% 4.25% 4.50% 4.75% 5.00% 5.25% 5.50% 5.75% 6.00% 6.25%

1.81% 85.29 81.27 77.65 74.37 71.39 68.67 66.17 63.88 61.76 59.80 57.97

2.06% 82.82 79.05 75.64 72.55 69.72 67.14 64.77 62.58 60.56 58.68 56.94

2.31% 80.50 76.96 73.74 70.82 68.14 65.69 63.43 61.35 59.41 57.62 55.95

2.56% 78.33 74.98 71.95 69.18 66.64 64.31 62.16 60.17 58.32 56.60 54.99

2.81% 76.28 73.12 70.25 67.63 65.22 63.00 60.94 59.04 57.27 55.62 54.08

3.06% 74.34 71.37 68.65 66.15 63.86 61.74 59.78 57.96 56.26 54.68 53.20

3.31% 72.52 69.70 67.12 64.75 62.57 60.54 58.67 56.92 55.30 53.78 52.35

3.56% 70.79 68.12 65.67 63.42 61.33 59.40 57.60 55.93 54.37 52.91 51.54

3.81% 69.16 66.62 64.29 62.14 60.15 58.30 56.58 54.98 53.48 52.07 50.75

4.06% 67.61 65.20 62.98 60.93 59.02 57.25 55.60 54.06 52.62 51.27 49.99

4.31% 66.13 63.84 61.72 59.76 57.94 56.25 54.67 53.19 51.80 50.49 49.26

US

ris

k fre

e r

ate

Market risk premiumRun

5.06% 5.26% 5.46% 5.66% 5.86% 6.06% 6.26% 6.46% 6.66% 6.86% 7.06%

10.12% 71.89 71.22 70.56 69.92 69.29 68.67 68.07 67.47 66.89 66.32 65.76

10.37% 70.20 69.56 68.94 68.33 67.73 67.14 66.57 66.01 65.45 64.91 64.38

10.62% 68.59 67.99 67.40 66.82 66.25 65.69 65.15 64.61 64.08 63.57 63.06

10.87% 67.07 66.50 65.93 65.38 64.84 64.31 63.79 63.28 62.78 62.29 61.80

11.12% 65.62 65.08 64.54 64.02 63.50 63.00 62.50 62.01 61.53 61.06 60.60

11.37% 64.24 63.73 63.22 62.72 62.22 61.74 61.27 60.80 60.35 59.90 59.45

11.62% 62.93 62.44 61.95 61.47 61.00 60.54 60.09 59.65 59.21 58.78 58.36

11.87% 61.68 61.21 60.74 60.29 59.84 59.40 58.97 58.54 58.12 57.71 57.31

12.12% 60.49 60.03 59.59 59.15 58.72 58.30 57.89 57.48 57.08 56.69 56.30

12.37% 59.34 58.91 58.49 58.07 57.66 57.25 56.86 56.47 56.08 55.70 55.33

12.62% 58.25 57.84 57.43 57.03 56.64 56.25 55.87 55.49 55.12 54.76 54.40

Pre-tax cost of debt

Co

st o

f e

qu

ity

Run


PAGE 32/32

Disclosures and Disclaimer

Research Recommendations

Buy Expected total return (including dividends) of more than 15% over a 12-month period.

Hold Expected total return (including dividends) between 0% and 15% over a 12-month period.

Sell Expected negative total return (including dividends) over a 12-month period.

This report was prepared by Michael Lüffe, a student of the NOVA School of Business and Economics, following the Masters in Finance Equity Research – Field Lab Work Project, exclusively for academic purposes. Thus, the author, which is a Masters in Finance student, is the sole responsible for the information and estimates contained herein and for the opinions expressed, which reflect exclusively his/her own personal judgement. This report was supervised by professor Rosário André (registered with Comissão do Mercado de Valores Mobiliários as financial analyst) who revised the valuation methodology and the financial model. All opinions and estimates are subject to change without notice. NOVA SBE or its faculty accepts no responsibility whatsoever for the content of this report nor for any consequences of its use. The information contained herein has been compiled by students from public sources believed to be reliable, but NOVA SBE or the students make no representation that it is accurate or complete, and accept no liability whatsoever for any direct or indirect loss resulting from the use of this report or its content. The author hereby certifies that the views expressed in this report accurately reflect his/her personal opinion about the subject company and its securities. He/she has not received or been promised any direct or indirect compensation for expressing the opinions or recommendation included in this report. The author of this report may have a position, or otherwise be interested, in transactions in securities which are directly or indirectly the subject of this report. NOVA SBE may have received compensation from the subject company during the last 12 months related to its fund raising program. Nevertheless, no compensation eventually received by NOVA SBE is in any way related to or dependent on the opinions expressed in this report. The Nova School of Business and Economics, though registered with Comissão do Mercado de Valores Mobiliários, does not deal for or otherwise offers any investment or intermediation services to market counterparties, private or intermediate customers. This report may not be reproduced, distributed or published without the explicit previous consent of its author, unless when used by NOVA SBE for academic purposes only. At any time, NOVA SBE may decide to suspend this report reproduction or distribution without further notice.

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