DELTA (DAL) AND SOUTHWEST (LUV) AIRLINES:
ANALYSIS AND VALUATION
FISV 5700: Financial Reporting and Control
Professor Joshua Cartwright
Johnson & Wales University
Andrex Ibiza
December 5, 2020
This paper was produced for educational purposes only and does not constitute professional financial advice. Please consult with an investment professional before making any investment decisions, which involve risk and the potential loss of funds invested.
Executive Summary
Short Term Liquidity
Delta's liquidity performance lags behind Southwest and the airline industry as a whole. Going into the beginning of 2020 and the COVID-19 pandemic, Delta's liquid assets were low relative to its current liabilities. Delta maintains a liquidity edge over Southwest only in terms of net operating working capital (NOWC). Concerning the current ratio, quick ratio, and net working capital (NWC), Southwest maintains a stronger liquidity position than Delta in relative terms. Southwest's quick ratio overperformed the airline industry average from 2017 – 2019.
Capital Structure and Solvency
Delta has a stable capital structure in terms of debt-to-equity and outperforms the industry average, but lags behind Southwest, which maintains consistently minimal levels of short- and long-term debt. Based on cash flows, the EBITDA coverage ratio indicates a stable financial picture for Delta, but the firm appears to present a greater long-term credit risk than Southwest. Southwest has continually improved its credit position from 2015-2019, whereas Delta continues to underperform the industry's metrics. Southwest leads the airline industry in its creditworthiness and capacity to engage in CAPEX utilizing free operating profit while also servicing the needs of both short- and long-term debts.
Asset Utilization
Both Delta and Southwest demonstrate a high level of skill at managing assets on behalf of investors. Whether looking at total asset turnover, inventory turnover, A/R turnover, DSO, both firms consistently outperform airline industry averages. Southwest outperforms Delta in this category, but Delta nonetheless remains in a competitive position relative to the rest of the market.
Profitability
Delta consistently yields superior investor value over time, when compared to Southwest and the overall industry. Delta enjoys superior ROE, ROA, FL, operating profitability, EBIT growth, EPS, and DPS over Southwest. According to these conventional metrics for corporate profitability, Delta outperforms airline competitors in its outstanding level of long-term value creation for shareholders.
Valuation Analysis
The DCF model projects a target stock price of $84.17 per share. The ROPI model predicts a target price of $57.81 per share. With a current stock price of $41.74/share, as of this writing, both models indicate that Delta is currently undervalued and indicates strong upside potential from its current price level.
Recommendation: Buy And Hold
Short Term Liquidity
Current Ratio = ( Current Assets / Current Liabilities )
The current ratio provides a measure of company liquidity, reflecting cash and cash equivalents' availability to fund short-term obligations to suppliers and creditors. Easton et al. (2021) define liquidity as "cash availability: how much cash a company has, and how much it can generate on short notice." They define current assets as those expected to convert to cash within the next year; current liabilities require payment within the following year. Based on the most recent 2019 annual data, Southwest significantly outperforms Delta but underperforms the industry average (Easton et al., 2021). Though concerning regarding Delta, both Southwest and Delta have maintained relatively stable current ratios over time, reflecting the specific capital structures and strategies that the companies have selected.
from matplotlib import pyplot as plt
import pandas as pd
import seaborn as sns
import numpy as npdf = pd.DataFrame(
{'Year':[2015, 2016, 2017, 2018, 2019,
2015, 2016, 2017, 2018, 2019,
2015, 2016, 2017, 2018, 2019],
'Airline':['DAL','DAL','DAL','DAL','DAL',
'LUV','LUV','LUV','LUV','LUV',
'IND', 'IND', 'IND', 'IND', 'IND'],
'Current Ratio':[0.35, 0.41, 0.33, 0.28, 0.35,
0.54, 0.66, 0.70, 0.64, 0.67,
0.80, 0.85, 0.99, 1.13, 1.01]})
sns.set_style("darkgrid")
sns.set_palette("Set1")
sns.set_context("talk")
sns.lineplot(
data=df,
x="Year",
y="Current Ratio",
hue="Airline",
style="Airline",
legend='auto')
plt.title("Current Ratio")
plt.xlabel('')
plt.ylabel('')
plt.legend(
bbox_to_anchor=(1.05, 1),
loc='upper left',
borderaxespad=0)
plt.axis([2015, 2019, 0.2, 1.2])
plt.savefig("current_ratio.png")
plt.show()Quick ("Acid Test") Ratio = ( [Current Assets – Inventories] / [Current Liabilities] )
In contrast to the Current Ratio, the Quick Ratio utilizes a more specific definition of current assets, focusing on those short-term assets that can quickly convert to cash. Quick assets include cash, marketable securities, and accounts receivable. They exclude inventories and prepaid assets because these current assets would take longer to convert to cash. To quickly liquidate inventories, for example, would require markdowns. Thus, the quick ratio offers a stricter definition of short-term liquidity than the current ratio. Southwest has maintained a quick liquidity level roughly double that of Delta. Relative to both Southwest and the industry average, the current ratio. However, at the end of 2019, Delta's quick ratio position was slightly above the overall industry average, only because that average liquidity level declined steadily from December 2015 to December 2019. Since 2017, Southwest's quick ratio position consistently outperformed Delta's.
df = pd.DataFrame(
{'Year':[2015, 2016, 2017, 2018, 2019,
2015, 2016, 2017, 2018, 2019,
2015, 2016, 2017, 2018, 2019],
'Airline':['DAL','DAL','DAL','DAL','DAL',
'LUV','LUV','LUV','LUV','LUV',
'IND', 'IND', 'IND', 'IND', 'IND'],
'Quick Ratio':[.31, .35, .26, .22, .28,
.5,.61,.64,.58,.61,
.75,.78,.36,.54,.25]})
sns.set_style("darkgrid")
sns.set_palette("Set1")
sns.set_context("talk")
sns.lineplot(
data=df,
x="Year",
y="Quick Ratio",
hue="Airline",
style="Airline",
legend='auto')
plt.title("Quick Ratio")
plt.legend(
bbox_to_anchor=(1.05, 1),
loc='upper left',
borderaxespad=0)
plt.axis([2015, 2019, 0.2, 0.8])
plt.xlabel('')
plt.ylabel('')
plt.savefig("quick_ratio.png")
plt.show()Net Working Capital (NWC) = Current Assets – Current Liabilities
In contrast to the previous two liquidity measures, NWC is a measure of the dollar value of a company's working capital position, with current liabilities subtracted from current assets. Instead of using a ratio, this answers the question, "how much cash remains to service current liability obligations?" In both firms, neither Delta nor Southwest have the cash on hand to satisfy these obligations without the use of additional external financing. Both underperform the industry average, but Delta sits in a tenuous current asset position in absolute terms.
df = pd.DataFrame(
{'Year':[2015, 2016, 2017, 2018, 2019,
2015, 2016, 2017, 2018, 2019,
2015, 2016, 2017, 2018, 2019],
'Airline':['DAL','DAL','DAL','DAL','DAL',
'LUV','LUV','LUV','LUV','LUV',
'IND', 'IND', 'IND', 'IND', 'IND'],
'Net Working Capital':[-11372,-9035,-12614,-13441,-13217,
-3382, -2346,-2090, -2877, -2978,
-25.38,-23.13,-0.17, 30.10, 3.56]})
sns.set_style("darkgrid")
sns.set_palette("Set1")
sns.set_context("talk")
sns.lineplot(
data=df,
x="Year",
y="Net Working Capital",
hue="Airline",
style="Airline",
legend='auto')
plt.title("Net Working Capital")
plt.legend(
bbox_to_anchor=(1.05, 1),
loc='upper left',
borderaxespad=0)
plt.xlabel('')
plt.ylabel('$ Millions')
plt.axis([2015, 2019, -14000,1000])
plt.savefig("net_working_capital.png")
plt.show()Net Operating Working Capital (NOWC) = Operating Assets – Operating Liabilities
Net Operating Working Capital provides a narrower definition of the company's assets and liabilities to exclude non-operating items. Operating assets include A/R, Inventories, prepaid expenses, PP&E (incl. owned and leased assets), intangibles, goodwill, deferred income tax assets, and "equity method" investments (strategic ventures with partners/associated companies/joint partners). Operating liabilities include A/P, accruals, unearned/deferred tax revenues, income taxes payable, deferred income tax liabilities, and pension/post-employment obligations (Easton et al., 2021). This analysis does not calculate the industry average for this metric; the two firms' competitive positions are of interest. In terms of NOWC, Delta maintains a relatively better position over Southwest.
df = pd.DataFrame(
{'Year':[2015, 2016, 2017, 2018, 2019,
2015, 2016, 2017, 2018, 2019],
'Airline':['DAL','DAL','DAL','DAL','DAL',
'LUV','LUV','LUV','LUV','LUV'],
'Net Operating Working Capital':[-2555,-1686,-3004,-2446,-1058,
-3382, -2346,-2090, -2877, -2978]})
sns.set_style("darkgrid")
sns.set_palette("Set1")
sns.set_context("talk")
sns.lineplot(
data=df,
x="Year",
y="Net Operating Working Capital",
hue="Airline",
style="Airline",
legend='auto')
plt.title("Net Operating Working Capital")
plt.legend(
bbox_to_anchor=(1.05, 1),
loc='upper left',
borderaxespad=0)
plt.xlabel('')
plt.ylabel('$ Millions')
plt.axis([2015, 2019, -4000,0])
plt.savefig("net_operating_working_capital.png")
plt.show()Delta's liquidity performance lags behind Southwest and the airline industry as a whole. Going into the beginning of 2020 and the COVID-19 pandemic, Delta's liquid assets were low relative to its current liabilities. Delta maintains a liquidity edge over Southwest only in terms of net operating working capital (NOWC). Concerning the current ratio, quick ratio, and net working capital, Southwest maintains a stronger liquidity position than Delta in relative terms. Southwest's quick ratio overperformed the airline industry average from 2017 – 2019.
Capital Structure and Solvency
Debt Ratio = Total Debt / Total Assets
A firm's capital structure refers to the company's proportions of debt and equity financing. In contrast to liquidity, which refers to a firm's ability to finance its short-term obligations, solvency refers to a firm's ability to service its long-term debt obligations. The debt ratio provides a measure of the company's long-term debt compared to its total assets. The debt ratio measures solvency but also provides hints about capital structure. In the long run, a firm with too much debt relative to total assets faced increased bankruptcy risk (Easton, 2011). Both Delta and Southwest have maintained competitive, low debt levels, but Southwest has consistently maintained a minimum long-term debt level relative to Delta.
df = pd.DataFrame(
{'Year':[2015, 2016, 2017, 2018, 2019,
2015, 2016, 2017, 2018, 2019,
2015, 2016, 2017, 2018, 2019],
'Airline':['DAL','DAL','DAL','DAL','DAL',
'LUV','LUV','LUV','LUV','LUV',
'IND', 'IND', 'IND', 'IND', 'IND'],
'Debt Ratio':[.29, .24, .27, .27, .27,
.15, .17, .19, .17, .08,
.27, .34, .32, .62, .52]})
sns.set_style("darkgrid")
sns.set_palette("Set1")
sns.set_context("talk")
sns.lineplot(
data=df,
x="Year",
y="Debt Ratio",
hue="Airline",
style="Airline",
legend='auto')
plt.title("Debt Ratio")
plt.legend(
bbox_to_anchor=(1.05, 1),
loc='upper left',
borderaxespad=0)
plt.xlabel('')
plt.ylabel('')
plt.axis([2015, 2019, 0, 0.65])
plt.savefig("debt_ratio.png")
plt.show()Debt-to-Equity Ratio = Total Debt / Total Equity
The Debt-to-Equity ratio provides a firm capital structure measure, the firm's relative mix of debt and equity. Determining whether or not the firms maintain a suitable capital structure offers essential context for conducting valuation projections. If this structure is appropriate, analysts attempt to keep that existing structure when forecasting additional borrowing, debt repayment, stock sales, or stock repurchases (Easton, 2021).
Over the period 2015 – 2019, the airline industry as a whole took on vast new amounts of debt relative to total equity, expanding by 309 percent. In comparison, both Delta and Southwest have maintained reasonable, relatively stable levels of debt compared to the industry's obligations as a whole. Since the interest on debt payments is tax-deductible, but dividend payments are not, the higher relative proportion of debt in Delta's capital structure grants the firm a competitive tax position relative to Southwest.