Should Investors Take A Flier on Delta Air?
Airline's Shares Have Surged, But Chapter 11 Filing, Fuel Costs Remain Wild Cards in Recovery
By EVAN PEREZ
Staff Reporter of THE WALL STREET JOURNAL
July 2, 2004; Page C1
Some Delta Air Lines shareholders seem convinced that the clouds hanging over the third-largest U.S. airline are lifting. Its stock price is up more than 50% since May 10, when Delta Air Lines warned it might have to file for bankruptcy-court protection. The surge, by far the biggest of any major carrier, has been propelled by the retreat of high fuel prices and word that the airline's pilots union is ready to return to the bargaining table with a sweetened wage-concessions offer.
But Delta could be about to hit more rough air soon -- and its shares could have trouble maintaining their level. The biggest problem: Management and pilots still are a long way from an agreement, and the two sides are almost certain in the next few months to fight a high-stakes game of financial chicken over givebacks that the airline maintains are essential to its survival.
If the back-and-forth rhetoric triggers a new round of worries that Delta can't fix its problems without heading to bankruptcy court, its stock could tumble. That is exactly what happened when contract bluster at Delta intensified earlier this year, helping to push the airline's shares down by nearly two-thirds between mid-January and their nearly 20-year low of $4.54 in May. In 4 p.m. New York Stock Exchange composite trading yesterday, Delta shares fell eight cents, or 1.1%, to $7.04.
It doesn't help that Delta management still is casting about for the right plan to restructure the Atlanta-based airline.
Gerald Grinstein, who became chief executive in January, has shared few details about his strategy, though he told employees in a memo yesterday that "we're leaving no stone unturned" in a turnaround plan that will go to Delta's board in late August. But the slow-moving process could complicate any new wage-cut negotiations.
Meanwhile, weak passenger revenue and fuel costs that remain historically high threaten to keep eating away at Delta's cash cushion, which shrank 19% to $2.2 billion in the first quarter compared with three months earlier, due mostly to pension and debt payments. It adds up to a sweat-it-out summer that will probably cause some grief for Delta shareholders, some analysts contend.
"At a minimum, we expect Chapter 11 rhetoric to worsen as the summer progresses," J.P. Morgan airline analyst Jamie Baker wrote in a research note.
Mr. Baker, who rates the stock "overweight" and believes Delta may face a decision on a bankruptcy-court filing by year's end, says the stock may fall below $2 before rallying. J.P. Morgan and its affiliates own 1% of Delta stock and the bank has done investment banking or other work for the company in the past year, according to a company spokesman.
Delta has gone from being one of the strongest airlines to a financial mess, piling up losses of more than $3.6 billion in the past three years. It faces pressure to slash overhead so it can compete against lower-cost carriers such as AirTran Holdings Inc.'s AirTran Airways and JetBlue Airways that have invaded Delta's home turf on the East Coast. Delta's costs also are higher than those of larger rivals AMR Corp.'s American Airlines and UAL Corp.'s United Airlines. United and American squeezed concessions from their unions through Chapter 11 or the threat of it.
So why would anyone buy Delta shares? Some investors are making an early bet that the stock is bound to surge even more when the carrier strikes a deal with pilots. In May, Lehman Brothers analyst Gary Chase boosted his rating on Delta to "overweight" from "equal weight," concluding that its shares had fallen so far that "we find them very compelling." Lehman Brothers and its affiliates owned 1% or more of Delta shares as of the end of May, the company said.
Mr. Chase is among several analysts who are convinced a pay-cut agreement will come in time to avoid a bankruptcy filing. But he acknowledged that his bullish call on Delta's stock "is extremely risky. We see value in the shares, but they could easily go lower before things improve," he wrote in a research note. He put a $10 target on the stock.
Mr. Grinstein has been telling Delta employees in meetings that the airline is doing all it can to avoid a bankruptcy filing. Still, management and the Air Line Pilots Association at Delta are about $500 million a year apart despite the union's willingness to restart talks. Delta is seeking more than $800 million in annual wage cuts and productivity improvements, while the pilots so far have offered about $300 million a year. Delta's request would cut pilot compensation by 45%. A joke among the pilot group is that with Delta's market value at about $870 million, the pilots could buy the airline instead of handing over about as much in concessions.
Delta and the union are scheduled to enter full contract talks in August, covering a broader and thornier range of issues than just pilot pay. Delta already is signaling that it may be too late for the pilots to accept the company's $800 million-a-year offer that has been on the table for months. Mr. Grinstein says the airline's concessions demand will need to increase once full-blown contract negotiations start.
Delta also needs to be thrown a lifeline from its debtholders. About $2 billion of Delta's $20 billion in debt matures in 2005 and 2006, and an additional $8 billion of that $20 billion in debt is secured by aircraft under covenants that are difficult to restructure outside of bankruptcy protection.
Analysts suggest that Delta needs to trim its aircraft debt by $300 million -- double the amount cut by American.
Delta creditors announced last Monday the formation of a committee to pursue restructuring talks with the airline. That move could make finding a way out of the financial crisis even more complicated, since the airline's pilots and debtholders could try to outlast each other on how much each group will give up toward salvaging the carrier. The committee includes secured- and unsecured-debt holders, vendors and representatives of the pilots union, according to Jonathan Rosenthal, partner at Saybrook Capital LLC, an investment company retained to advise the committee.
Delta "will need to prove to be very successful negotiators with creditors as well as labor groups if they are to execute on a plan to meet the demand for a dramatically revamped cost structure," Credit Sights analysts Roger King and Glenn Reynolds told clients in a research note last week.
Michael Palumbo, Delta's chief financial officer, said recently that easing the debt load is "a major challenge," though there are chunks of Delta's debt that could be restructured without a trip to bankruptcy court.
For now, Mr. Palumbo is plowing ahead with efforts to find another $800 million in annual productivity savings outside of pilot givebacks, adding to $1.2 billion in efficiency improvements Delta made in the past year. "We will examine every cost component, of which the pilot is just one," he said. "What we're endeavoring to achieve at Delta is a plan for viability, not just momentary profitability."
Ray Neidl, airline analyst with Blaylock & Partners LP, estimates that Delta needs to squeeze annual cost savings of $2.1 billion from its operations to become competitive with other major carriers. "The efficiencies have to be driven across the board," he said. Mr. Neidl is sticking to his "sell" recommendation, figuring the stock is headed toward $4 in the coming months. Mr. Neidl said he owns "a few hundred" shares of Delta and Blaylock has no business relationship with Delta.
Write to Evan Perez at evan.perez@wsj.com
