Why Airline Stocks Should Be on Your Income Radar

Recent dividend increases like those by LUV and DAL should become more norm than exception

I’ll be the first to admit that investing in airline stocks is tricky at the moment. If nothing else, the selloff that airline stocks faced in late May due to pricing concerns is a pointer.

But I want to make a bold call here: It’s time for investors to not just consider airline stocks — but to consider them as income plays.

Yes, Southwest Airlines (LUV) and Delta Air Lines (DAL) both yield south of 1% right now. But I think we’re starting to see a trend that should soon change that.

In fact, just recently, both companies put a significant jolt into their quarterly payouts — something that should become a more common occurrence.

Airline Stocks: Once the Cheapskates of the Skies

The airline industry traditionally hasn’t been too generous about returning value to shareholders in form of a dividend. In fact, as of the beginning of 2013, LUV was the only major U.S. airline paying dividend; DAL and Alaska Air Group (ALK) only joined later that year.

It wasn’t until the second quarter of 2014 that American Airlines (AAL) started paying a paltry quarterly dividend of 10 cents. American had paid out a dividend decades ago, with its last payout coming in 1980, a couple years before it became AMR Corp.

As you might have guessed, a large part of why airlines have been so skimpy on the dividend front has been past profitability struggles.

But we might be in the midst of a new dawn for airline stocks.

Competition in the Airline Industry Is Now Healthy

Most of what you’ve heard about the newfound profitability in the U.S. airline industry has been attributed to lower fuel expenditure. That’s valid, considering that fuel costs take a big chunk of airline expenses.

However, the benefits of industry consolidation have really been underplayed.

In the actual scheme of things, high fuel costs don’t really make airlines unprofitable. Sure, high fuel costs weigh on margins, but ultimately, passengers are the ones who truly pay for those greater costs.

No, the stern competition in the airline industry over the years has been the biggest enemy to profitability. Competition has limited airlines’ earning power, and also weighed on airlines’ expenses, as it simply costs more in advertising and updates to stay relevant in the industry.

For instance, AAL, LUV and DAL have all grown operating revenues faster than their operating expenses since their respective mergers.

American merged with US Airways in 2013, and operational efficiency shot through the roof. No surprise, considering that US Airways said prior to the merger that the joining could yield “more than $1.5 billion a year in added revenue and cost saving.”

In the same vein, after Southwest merged with AirTran in 2012, LUV was able to grow its revenue faster than its operating expenses.

Delta merged with Northwest in 2008. That year, the margin between DAL’s operating revenue and operating expenses was -$8.314 billion. However, by 2009, that figure was -$324 million, and while the margin between operating revenues and expenses took a hit between 2013 and 2014 (as you can see in the chart below), it’s still far better than it was back in 2008.

AAL, DAL, LUV operating margin

A sensible conclusion: Competition made profits difficult to come by.

But, if you’re not convinced that competition has been an issue, just why are major U.S. airlines so bitter over the alleged subsidy that Gulf carriers — EtihadQatar and Emirates — receive? You’re right, it’s a competitive disadvantage for them, internationally.

If the Gulf carriers truly receive subsidies from their respective governments, then they have higher ability to control costs and stay profitable than U.S. airlines. This is why the Gulf carriers always rank better than U.S. airlines on international rankings — as U.S. airline execs claim.

But consolidation has helped airlines’ operations, and that helps profits — profits that can be diverted to shareholders in the forms of a dividend.

Airline Stocks To Watch

Delta Air Lines (DAL): Delta’s cash flow is increasing at an impressive rate, and the company also has been reducing its debt; long-term debt has dropped from nearly $12 billion in 2011 to less than $9 billion last year.

Meanwhile, Delta in May approved a $5 billion share repurchase program, as well as a 50% dividend hike (effective in the September quarter). That would take the quarterly payout from 9 cents to 13.5 cents, which would lift the yield on DAL stock from 0.9% to 1.3%, based on current prices. With the new payout, Delta’s dividend will have increased 125% from its original 6-cent offering in 2013.

Southwest Airlines (LUV): Southwest also has been improving its foundation, with cash flow from operating activities increasing more than 40% from 2012 to 2014. During the same period, long-term debt has been sliced by 15.6%.

Like DAL, LUV stock just got a lot more shareholder-friendly. The airline recently upped its quarterly dividend from 6 cents to 7.5 cents — as 25% increase — that brings its yield to about 0.9%. Still modest? Sure. But it’s leaps and bounds from the 0.45-cent dividend LUV paid out as recently as 2011.

American Airlines (AAL): American still has to digest its merger with US Airlines, but it’s clearly one of the biggest beneficiaries of consolidation, up some 55% since emerging from bankruptcy as the new current entity. AAL stock currently pays out about 1% on a 10-cent quarterly dividend, and as its margins continue to improve, there should be room to thicken that payout.

As of this writing, Craig Adeyanju did not hold a position in any of the aforementioned securities.

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Article printed from InvestorPlace Media, https://investorplace.com/2015/06/airline-stocks-dividends-aal-dal-luv/.

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