Investors Are Undervaluing Delta Air Lines Inc (NYSE:DAL) By 41.45%

Terrence Jolly

I am going to run you through how I calculated the intrinsic value of Delta Air Lines Inc (NYSE:DAL) by estimating the company’s future cash flows and discounting them to their present value. This is done using the Discounted Cash Flows (DCF) model. It may sound complicated, but actually it is quite simple! If you want to learn more about discounted cash flow, the basis for my calcs can be read in detail in the Simply Wall St analysis model. If you are reading this and its not September 2018 then I highly recommend you check out the latest calculation for Delta Air Lines by following the link below.

View our latest analysis for Delta Air Lines

The method

We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second ‘steady growth’ period. To start off with we need to estimate the next five years of cash flows. For this I used the consensus of the analysts covering the stock, as you can see below. I then discount the sum of these cash flows to arrive at a present value estimate.

5-year cash flow forecast

2019 2020 2021 2022 2023
Levered FCF ($, Millions) $5.05k $4.67k $4.76k $4.85k $4.94k
Source Analyst x4 Analyst x1 Est @ 1.89% Est @ 1.89% Est @ 1.89%
Present Value Discounted @ 9.49% $4.61k $3.90k $3.63k $3.38k $3.14k

Present Value of 5-year Cash Flow (PVCF)= US$18.65b

The second stage is also known as Terminal Value, this is the business’s cash flow after the first stage. The Gordon Growth formula is used to calculate Terminal Value at an annual growth rate equal to the 10-year government bond rate of 2.9%. We discount this to today’s value at a cost of equity of 9.5%.

Terminal Value (TV) = FCF2022 × (1 + g) ÷ (r – g) = US$4.94b × (1 + 2.9%) ÷ (9.5% – 2.9%) = US$77.81b

Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = US$77.81b ÷ ( 1 + 9.5%)5 = US$49.46b

The total value is the sum of cash flows for the next five years and the discounted terminal value, which results in the Total Equity Value, which in this case is US$68.11b. In the final step we divide the equity value by the number of shares outstanding. If the stock is an depositary receipt (represents a specified number of shares in a foreign corporation) or ADR then we use the equivalent number. This results in an intrinsic value of $98.89. Relative to the current share price of $57.9, the stock is quite good value at a 41.5% discount to what it is available for right now.

NYSE:DAL Intrinsic Value Export September 20th 18

The assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. If you don’t agree with my result, have a go at the calculation yourself and play with the assumptions. Because we are looking at Delta Air Lines as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighed average cost of capital, WACC) which accounts for debt. In this calculation I’ve used 9.5%, which is based on a levered beta of 0.927. This is derived from the Bottom-Up Beta method based on comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.

Next Steps:

Valuation is only one side of the coin in terms of building your investment thesis, and it shouldn’t be the only metric you look at when researching a company. What is the reason for the share price to differ from the intrinsic value? For DAL, I’ve put together three pertinent aspects you should further research:

  1. Financial Health: Does DAL have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
  2. Future Earnings: How does DAL’s growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.
  3. Other High Quality Alternatives: Are there other high quality stocks you could be holding instead of DAL? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!

PS. Simply Wall St does a DCF calculation for every US stock every 6 hours, so if you want to find the intrinsic value of any other stock just search here.

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.