2 Interesting Stocks to Buy on a Decline During Earnings Season

It is always interesting to monitor stocks to buy during earnings season if the market overreacts to any negative news. With that in mind, I think Delta Airlines (DAL 1.52%) And Hexcel Company (HXL 2.28%) are worth a look. Both stocks have sold off recently, and I think the market is treating them a little too harshly. Here’s why.

Delta Air Lines and Market Cyclicity

Supply and demand determine prices in a free market, and this is true in the airline industry. So airlines can raise prices when demand exceeds supply, but they will experience yield pressure when this happens. Unfortunately, the airline industry has experienced cycles of plenty and famine, with airlines historically maintaining high capacity during lean times.

With the industry commentary out of the way, it’s time to look at what’s happening now. It’s clear that after a period of strong demand growth—particularly due to passengers catching up on travel plans postponed due to pandemic lockdowns—airlines have dramatically increased capacity so that supply is outpacing demand. The result is that airlines like Delta Air Lines and United Airlines reported slightly disappointing second-quarter results and gave moderate guidance for the third quarter.

For example, Delta Air Lines expects third-quarter revenue to increase 2% to 4%, despite expected capacity growth of 5% to 6%, indicating pressure on yield.

This time it’s different?

While these last words are among the most famous in investing, they may be true in this case. In a perfect world, market participants tend to gradually “price in” risk as it increases. However, in reality, they often refuse to do so until a major shock event occurs and temporarily changes perceptions. I believe the pandemic has been that shocking event, and the airline industry may well learn to be more responsive, reducing capacity when demand outstrips supply, as it is doing now.

That’s what Delta management seems to think, with Chairman Glen Hauenstein saying on the recent earnings call, “I’ve never seen the industry respond so quickly to oversupply,” and “the industry has responded before. And I think that’s very different than a few years ago, where supply would stay so high for long periods of time.”

CEO Ed Bastian stressed that capacity reduction was the first lever that loss-making airlines could pull to improve their performance.

United Airlines management shares the same view. CEO Scott Kirby says industry capacity outpaced demand in the second quarter. However, industry rationalization is already underway. Kirby says it “will start to happen in earnest in the second half of August in schedules” and “it looks like domestic capacity growth will slow by about 5 percentage points by the fourth quarter compared to where it was in the second quarter.”

As such, don’t be surprised if pricing conditions improve in the third quarter, and given that the low end of Delta’s $6-7 annual guidance puts it at 7.6 times 2024 earnings, the stock looks like an excellent value.

That said, investors should keep in mind that the recent Crowd strike The software update incident has caused Delta to cancel thousands of flights and the airline will have to refund customers and could face lawsuits in the third quarter. Therefore, cautious investors may want to wait to hear management’s update on the matter and a likely impact on third-quarter earnings before buying.

Hexcel’s short-term challenges

A producer and marketer of advanced graphite composites for the aerospace, space and defense and industrial sectors, Hexcel is experiencing near-term headwinds in its commercial aerospace end markets, but for entirely different reasons.

About 60% of its sales are to the commercial aerospace industry, with almost all of this going to Airbus, Boeing, and its subcontractors. Approximately 39% of its total revenue was generated by Airbus and its subcontractors in 2023, with Boeing and its subcontractors accounting for 15%.

So when Airbus and Boeing cut their aircraft delivery forecasts (as they did in 2024), Hexcel will see it in its sales. Demand for parts for its products is very low, so aircraft production is its main end market.

Unfortunately, Hexcel cut its full-year guidance during its second-quarter earnings call:

• Full-year sales are now expected to be between $1.9 billion and $1.98 billion, down from the previous range of $1.925 billion to $2.025 billion.
• Full-year adjusted diluted EPS is now expected to be in the range of $2.02 to $2.18, down from the prior range of $2.10 to $2.30.

A fast-growing stock at a reasonable price

The reduction in expectations is disappointing, especially as Hexcel was ramping up capacity to prepare for a bigger ramp-up of aircraft production in 2024, so its margins will also be weak.

That said, Airbus and Boeing still have several years of arrears, and the main way for them to increase their profits East by delivering more aircraft, especially since profit margins tend to increase in line with the volume of deliveries.

Management’s revised guidance calls for free cash flow of about $200 million this year, including more than $800 million in total from 2024 to 2026. That would put Hexcel at 26 times its 2024 free cash flow, and less than 20 times its free cash flow assuming average free cash flow of one-third of $800 million. That’s too cheap for a company that has a strong chance of growing revenue over the long term as aircraft deliveries accelerate and newer planes use more advanced composite content.