A Delta Play on Weakness

It's been difficult not to notice the beating that the airlines have taken this year. I wrote about that in this morning's Market Recon note. The industry as a group is off more than 8% year to date, while one name, Delta Air Lines (DAL) has been hit hard just this month -- dropping from $51.03 on the first of the month to where it closed on Friday, which was $46.51. What happened to the name? Increased competition, rising labor costs, a pop in fuel costs, and basically a dose of reality.   Let's take a little bit of a walk through the issues, and make up our minds. Delta now forecasts operating margin for the first quarter to drop to 10% to 11%. That is down from 11% to 13%. Delta forecasts revenue from cargo for the quarter to be lighter than previously expected, and raised its expectations for fuel costs for the quarter. Non-operating expenses are also now expected to be far larger than previously thought. That's a lot of ugly. Now the question for the guy or gal sitting in front of their computer becomes "Is the ugly all out?" Does it get better from here?   There are no sure things in our sport, but the answer is that it certainly could. Why? Where's the positive? For one thing, though February airfares were down 1.1% year over year, they actually popped 2.4% on a month over month basis.   The transports. Yes, the transports. Given that the DJTA is being held back almost exclusively by the airlines, I don't believe that classic Dow Theory is relevant in this case. The economy is growing at a paltry 0.9% (SAAR), if you trust the Atlanta Fed. Growth seems more poised to increase later this year, as the administration's economic agenda unfolds. Economic growth inspired by lower corporate taxes and spending on infrastructure will, if allowed to flower, create a larger market for business travel.   We already mentioned rising fares. Now, though airlines hedge their fuel costs ahead of time, there is suddenly downward pressure on future costs for fuel. It is no sure thing, but the picture is rosier for a firm that must spend less on fuel than it was two weeks ago when Delta made those forecasts.   Some other fun facts. Delta is cheap if the airlines are your game. The name trades at 8.2x forward earnings. United (UAL) (9.9x), American (AAL) (8.8x), and Alaska Air (ALK) (14.4x) are comparatively more expensive. DAL pays a 1.7% dividend yield. The others? ALK is at 1.3%, AAL 0.9% and UAL -- nada.   Am I sure about this play? Heck no, that's why we're going to cheapen our net effective cost through the sale of some options. In our example, as always, we use minimal lots. Remember, DAL reports quarterly earnings on Apr. 13. Feel free to push out the expirations on these sales as far as six months to suit your instincts, as the second half is where the better environment for this firm probably lies.   The Trade: (Prices are approximate, based on fluctuating markets.)   --Buy 100 shares of DAL equity at $46.75, or better;   --Sell 1 DAL 45 April 13 put at $0.61, or better;   --Sell 1 DAL 50 April 13 call at $0.40, or better.   The sale of the two options drops the effective cost of the trade from $46.75 to $45.74.   The put creates the most risk, as potentially you could end up long 200 shares should the prices of the stock drop below $45 on Apr. 13. That said, you will be long 200 shares at an average effective price of $45.37 in a name that you thought of buying at $47.00.   The perfect outcome would be to see DAL close above $50 on Apr. 13, where your profit is capped at $425.   I intend to initiate this trade, or one very similar once I see that the article is published.
Read the full story and get access to the Real Money Pro trading floor.

There’s no substitute for a trading floor to get great ideas, so Jim Cramer created a better one at Real Money and blogs there exclusively. We then added legendary hedge fund manager, Doug Kass, with his exclusive Daily Diary and best investing ideas. Staffed with more than 4 dozen investing pros, money managers, journalists and analysts, Real Money Pro gives you a flood of opinions, analysis and actionable trading advice found nowhere else, and allows you to interact directly with each expert.

Already a Subscriber? Please login.

Except as otherwise indicated, quotes are delayed. Quotes delayed at least 20 minutes for all exchanges. Market Data provided by Interactive Data. Company fundamental data provided by Morningstar. Earnings and ratings provided by Zacks. Mutual fund data provided by Valueline. ETF data provided by Lipper. Powered and implemented by Interactive Data Managed Solutions.

TheStreet Ratings updates stock ratings daily. However, if no rating change occurs, the data on this page does not update. The data does update after 90 days if no rating change occurs within that time period.

IDC calculates the Market Cap for the basic symbol to include common shares only. Year-to-date mutual fund returns are calculated on a monthly basis by Value Line and posted mid-month.