There are a number of global mega trends occurring right now.
And you can be a part of these mega trends in any number of ways.
You can experience them firsthand as a consumer, or you could sit back and watch the world take shape.
But I’d argue there’s only one way you should be thinking about these mega trends.
That’s as an investor.
This puts money, time, and opportunities in your pocket.
Spotting global mega trends has never been easier.
This means you almost can’t avoid what’s happening.
Better yet, taking advantage of these global mega trends as an investor has also never been easier.
That means more people than ever before have a chance to build real wealth.
I’d know from firsthand experience.
I went from below broke at 27 years old to financially free at 33.
As I describe in my Early Retirement Blueprint, I used intelligent long-term investing as a mechanism to escape poverty and become relatively wealthy at a young age.
And now my FIRE Fund, which is my real-money early retirement stock portfolio, generates the five-figure passive dividend income I live off of.
The intelligent long-term investment strategy I’ve used is dividend growth investing.
This strategy almost guarantees you exposure to global mega trends.
After all, it takes a world-class business earning the kind of big and growing profit necessary to sustain growing cash dividends year in and year out.
See what I mean by checking out the Dividend Champions, Contenders, and Challengers list.
Just about every global mega trend you can think of is represented on that list by at least one company.
And since every company on that list is paying growing cash dividends, you get paid reliable and growing income while you wait for things to unfold.
Of course, there’s a bit more to it than that.
Investing in high-quality companies is one thing.
But valuation at the time of investment is critical.
A long-term investor should always seek undervaluation.
I’ll tell you why.
An undervalued dividend growth stock should offer a higher yield, greater long-term total return potential, and reduced risk.
That’s relative to what the same stock might otherwise offer if it were fairly valued or overvalued.
Since price and yield are inversely correlated, a lower price will, all else equal, result in a higher yield.
This higher yield means greater long-term total return potential.
That’s because total return is comprised of capital gain and investment income.
A higher yield naturally means more possible investment income.
And then there’s the “upside”.
That’s the capital gain that’s available if/when the gap closes between price and value when there’s a favorable mispricing in the market.
These dynamics should also reduce risk.
An investor introduces a margin of safety when the price paid for a security is well below its estimated intrinsic value.
This offers some measure of protection, or a buffer, against unforeseen issues that can reduce a stock’s value.
You can see now why a long-term investor should always seek undervaluation.
Fortunately, it’s not that difficult to find it.
Fellow contributor Dave Van Knapp has made the valuation process easier than ever.
Through Lesson 11: Valuation, which is part of a larger series on DGI, he deftly explains exactly how to go about estimating the intrinsic value of dividend growth stocks.
With all of this in mind, let’s take a look at a high-quality dividend growth stock that appears to be undervalued right now…
Delta Air Lines, Inc. (DAL)
Delta Air Lines, Inc. (DAL) is a global airline company.
As of January 31, 2019, the company served more than 300 destinations worldwide in over 50 countries.
The company’s passenger revenue for FY 2018 breaks down geographically as follows: Domestic, 71%; Atlantic, 16%; Latin America, 7%; and Pacific, 6%.
Measured by revenue passenger miles, Delta Air Lines has an estimated 17% domestic market share.
I started this week’s piece off discussing global mega trends.
Well, there are few global mega trends larger than international tourism.
The fact is, globalization has made international tourism a far more affordable and accessible leisure activity than it’s ever been before.
And people all over the world are taking advantage of this.
Less than a century ago, being able to visit some faraway country was a luxury that few could indulge in.
But international tourism is now a juggernaut of an industry that offers far-reaching opportunities and consequences.
Even if we scale it down into just the United States, the domestic airline industry is a ~$175 billion market. That’s just one country.
According to the World Tourism Organization, there were 1.4 billion international tourist arrivals in 2018. That’s up ~6% compared to 2017.
Indeed, I’m currently living in Thailand, which is one of the most popular destinations for international tourists. And I see tourists from China, Europe, America, and Australia streaming in every single day.
That tells us that there’s great demand for global airlines.
After all, these people aren’t arriving by magic carpet.
This is very good news for large players like Delta Air Lines.
While the airline industry has historically been a poor place to invest, industry dynamics have become far more favorable.
That’s largely due to massive waves of bankruptcies and consolidations that have led to just a few major competitors standing. This substantial reduction in competition has created more rational pricing and much wider margins.
These airlines, simply put, are much better businesses than they’ve ever been. That’s fundamentally speaking.
Delta Air Lines itself is a good example of these waves.
The legacy company filed for bankruptcy in 2005, emerged from bankruptcy in 2007, and then merged with Northwest Airlines in 2008.
It’s a series of events that resulted in a much stronger airline in a more investor-friendly industry.
Better yet, this is a dividend-friendly company, which is something you wouldn’t have said a decade ago.
The company has increased its dividend for six consecutive years.
Although, that’ll be seven consecutive years when the CCC list is next updated, since the airline just increased its dividend mere days ago.
That dates back to when the company as we now know it first initiated its dividend.
Making up for lost time, the five-year dividend growth rate stands at an incredible 61.3%.
Now, it’s unrealistic to expect that kind of dividend growth to continue indefinitely.
However, the company did just raise their dividend by a full 15%.
And the stock now offers a yield of 2.68%.
So you’re getting double-digit dividend growth on top of a market-beating yield.
Moreover, that yield is almost 120 basis points higher than its five-year average.
With a payout ratio of only 23.8%, there’s plenty of room for many more sizable dividend increases.
A lot to like about the dividend, obviously.
But it’s future dividend increases that ultimately matter to investors.
Estimating that future dividend growth requires estimating future profit growth, since the latter largely gives capacity to the former over the long run.
I’ll go about estimating the company’s future growth trajectory by first looking at what they’ve done over the last decade. Then I’ll compare that result to a professional profit growth forecast.
Combining the known past with a professional future forecast like this should tell us a lot about where Delta Air Lines might be going.
The company increased its revenue from $28.063 billion in FY 2009 to $44.438 billion in FY 2018.
That’s a compound annual growth rate of 5.24%.
Very solid growth here. I usually look for mid-single-digit top-line growth from a mature company like this. They’re right on the money.
I’m actually now going to look at earnings per share growth over the last nine years.
So I’m shaving off a year. That’s because FY 2009 represented the nadir of the financial crisis, pushing the airline into a loss that year.
Furthermore, the merger with Northwest Airlines was completed not long before this period began.
Between FY 2010 and FY 2018, Delta Air Lines expanded its EPS from $0.70 to $5.67, which is a CAGR of 29.89%.
A fantastic result. But I think we have to keep in mind that this is skewed due to the nature of the starting point. The company was just beginning a long crawl out of a hole.
Still, it’s mighty impressive to see what this company has become when you compare it to what it was just 10 years ago.
Notably, there has been a sizable reduction in the outstanding share count – down by ~16% over the last decade.
Simultaneously, they’ve greatly expanded margins.
The whole industry is simply looking at a more advantageous set of dynamics. This rising tide has the effect of lifting all boats (or planes, in this case).
Looking forward, CFRA is predicting Delta Air Lines will compound its EPS at an annual rate of 12% over the next three years.
CFRA primarily cites fuel efficiency from the ongoing modernization of the fleet, continued share buybacks, and strong air travel demand for their projection.
Recent results by the company reinforce this.
The company’s loyalty program, Delta SkyMiles, helps retain customers in an industry that features effectively no switching costs.
This relates to a long-term relationship the carrier has with American Express Company (AXP).
Delta Air Lines sells miles to the credit card company, which is mutually beneficial.
This creates stickier customers on both sides. And it’s a great direct revenue source for the airline.
I also think it’s worth noting here that I’m unable to find any Boeing Co (BA) 737 Max aircraft in Delta Air Line’s fleet.
That means they’re totally insulated from the ongoing issues with that particular model. This simultaneously gives them an advantage over competitors that are dealing with groundings.
All in all, the 12% forecast seems reasonable to me.
And that easily sets up dividend growth investors for double-digit dividend growth for the foreseeable future, especially when you keep the low payout ratio in mind.
Moving over to the balance sheet, the company is sitting in a very good position.
While running an airline is a capital-intensive and asset-heavy business model, there’s clearly a thoughtful and responsible approach to leverage here.
The long-term debt/equity ratio is 0.60, while the interest coverage ratio is sitting at almost 19.
In my view, these are excellent numbers.
Profitability, as foreshadowed earlier, has improved markedly over the last decade.
Over the last five years, the company has averaged annual net margin of 8.26% and annual return on equity of 29.22%.
For perspective, the airline was regularly posting up low-single-digit net margin 5-10 years ago.
It’s clear that this has become a much higher-quality company across the board.
And I think the initiation and regular growth of the dividend is a result of that rise in fundamental quality.
This might be why Warren Buffett, who has long been against the idea of investing in airlines, has recently been scooping up shares in the airline.
Of course, there are risks to consider.
Regulation, litigation, and competition are omnipresent risks in every industry.
While competition has been reduced and become more rational in recent years, it remains fierce.
In addition, the age-old issues with the airline industry in general continue to plague these stocks from a long-term investment standpoint.
There’s the exposure to volatile fuel prices, high fixed costs, and acute sensitivity to economic cycles.
More specific and recent issues regarding the trade war between US and China, the late stage of the economic cycle, and Brexit are also undoubtedly risks for global airline companies.
But at the right valuation, this stock could be more compelling than it’s perhaps ever been.
Well, the stock does appear to be quite cheap right now…
The stock is trading hands for a P/E ratio of 8.91.
That’s about half the broader market.
Even for a stock that usually has a low P/E ratio – the five-year average is 12.2 – that’s insane.
The P/B ratio, at 3.1, is decidedly lower than its own five-year average of 5.0.
And the yield, as noted earlier, is substantially higher than its recent historical average.
So the stock does look cheap. But how cheap might it be? What would a reasonable intrinsic value estimate look like?
I valued shares using a dividend discount model analysis.
I factored in a 10% discount rate and a long-term dividend growth rate of 7.5%.
Admittedly, that DGR is on the higher end of what I ordinarily allow for.
But the low payout ratio, clear commitment to dividend raises, strong FCF, near-term growth prospects, share buybacks, and overall health of the business indicate I’m actually being conservative.
If anything, the company has the wherewithal to grow its dividend at a much higher rate than this, assuming there’s no global calamity or severe mishandling of the business by management.
The reason I use a dividend discount model analysis is because a business is ultimately equal to the sum of all the future cash flow it can provide.
The DDM analysis is a tailored version of the discounted cash flow model analysis, as it simply substitutes dividends and dividend growth for cash flow and growth.
It then discounts those future dividends back to the present day, to account for the time value of money since a dollar tomorrow is not worth the same amount as a dollar today.
I find it to be a fairly accurate way to value dividend growth stocks.
Even with a rather conservative valuation, the stock looks at worst fairly valued.
I think it’s better than that. The stock looks undervalued by most metrics.
But we’ll now compare that valuation with where two professional stock analysis firms have come out at.
This adds balance, depth, and perspective to our conclusion.
Morningstar, a leading and well-respected stock analysis firm, rates stocks on a 5-star system.
1 star would mean a stock is substantially overvalued; 5 stars would mean a stock is substantially undervalued. 3 stars would indicate roughly fair value.
Morningstar rates DAL as a 4-star stock, with a fair value estimate of $67.00.
CFRA is another professional analysis firm, and I like to compare my valuation opinion to theirs to see if I’m out of line.
They similarly rate stocks on a 1-5 star scale, with 1 star meaning a stock is a strong sell and 5 stars meaning a stock is a strong buy. 3 stars is a hold.
CFRA rates DAL as a 5-star “STRONG BUY”, with a 12-month target price of $75.00.
I came out right in line with Morningstar. Averaging the three numbers out gives us a final valuation of $70.41. That would indicate the stock is possibly 17% undervalued.
Bottom line: Delta Air Lines, Inc. (DAL) is a global company that is perfectly positioned to continue taking advantage of a global mega trend. The business has also dramatically improved across the board in recent years. And none other than Warren Buffett has been buying this stock hand over fist. With a market-beating yield, very low payout ratio, double-digit dividend growth, and the potential for 17% upside, dividend growth investors should have this stock on their radar.
Note from DTA: How safe is DAL’s dividend? We ran the stock through Simply Safe Dividends, and as we go to press, its Dividend Safety Score is 61. Dividend Safety Scores range from 0 to 100. A score of 50 is average, 75 or higher is excellent, and 25 or lower is weak. With this in mind, DAL’s dividend appears Safe with a very unlikely risk of being cut. Learn more about Dividend Safety Scores here.
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