Airlines Plan To Return Greater Cash To Shareholders As The Industry’s Finacial Health Improves

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Three major U.S. airlines have announced stock buybacks and dividend hikes this month. This development in the airline industry, which for most part of the last decade struggled to post profits let alone return capital to shareholders, is a highly welcome one and we figure is the result of the industry’s improved financial health. Enabled by solid demand for air travel and gains from consolidation, most U.S. airlines have improved their results in recent years. Backed by stronger balance sheets and the anticipation of sustained solid cash flow from operations, three airlines namely Delta (NYSE:DAL), Alaska (NYSE:ALK) and Southwest (NYSE:LUV) announced increased capital return to their shareholders this month. First, in early May, Delta hiked its dividend by 50% and announced share buybacks worth $2 billion through 2016. [1] Thereafter, last week on Monday Alaska authorized an additional $650 million for share buybacks. This came after the airline started paying quarterly dividends of 20 cents per share last August and hiked that to 25 cents per share in February this year. [2] Southwest Airlines on Wednesday last week also hiked its dividend by 50% and announced share buybacks worth $1 billion. [3]

Here we highlight the key factors that have enabled these airlines and will potentially enable other airlines in future to return greater cash to their shareholders.

See our complete analysis of Delta, Alaska and Southwest here

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Most U.S. Airlines Have Posted Higher Profits In The Last Few Years

Since the financial crisis of 2008-09, most U.S. airlines have improved their profits. A steady recovery in demand for air travel has played a crucial role in enabling airlines to book these higher profits. While, relatively stable jet fuel prices in the last year also contributed to better results. Delta for instance improved its profits from a loss of $1.2 billion in 2009 to a profit of $2.7 billion (excluding special items) in 2013. [4] Alaska also steadily improved its profits from $122 million in 2009 to $508 million in 2013 [5], while Southwest also grew its profits from a mere $99 million in 2009 to $754 million last year. [6] These higher profits enabled these carriers to pay down their debt loads which in turn further boosted their profits through lower interest expenses. Gradually, these carriers were required to make lower incremental debt and pension contributions leaving them with greater cash to disburse among shareholders, which has led to the recent spate of announcements for dividend hikes and share buybacks.

At the same time, this increased shareholder return highlights that Delta, Alaska and Southwest have confidence in sustaining their solid cash flows from operations in the coming years. We figure with the demand for air travel likely to remain strong and jet fuel prices also likely to remain steady due to rising crude oil production in the U.S., these airlines will likely be able to fulfill their increased shareholder return targets.

Some other airlines such as United (NYSE:UAL) that haven’t so far been able to improve their profits as per expectations have also indicated that they will begin returning cash to shareholders in the near future. For instance, United currently plans to begin returning cash to its shareholders next year even though it booked a loss of $609 million in the recently concluded March quarter. [7]

Consolidation Greatly Helped The Airline Industry Become Profitable

Apart from a recovery in the demand for air travel, we figure gains from industry consolidation have also played a key role in enabling airlines to book higher profits. The several bankruptcies and mergers of the last decade not only strengthened individual airlines but also lowered competition in the industry. In 2002, there were nine major U.S. airlines while currently there are four – American (NASDAQ:AAL), United, Delta and Southwest. Over the last decade, the airline industry consolidated through many mergers including the five big combinations of US Airways-America West in 2005, Delta-Northwest in 2008, United-Continental in 2010, Southwest-AirTran in 2011 and American-US Airways in 2013. As a result of this consolidation, overall price competition among airlines declined. At the same time, airlines seemed to have learnt the importance of capacity discipline. Earlier, airlines raised their flying capacities more freely in an attempt to capture greater market share even if that meant flying emptier planes. In contrast, currently most airlines are raising flying capacities at much lower rates with greater focus on flying fuller planes, which determines profitability.

Separately, the bankruptcies of many major carriers including Delta, United and American in the last decade enabled these carriers to lower their operating costs through re-negotiated labor contracts and other lease agreements. As a result, profits of these carriers rose on gains from lower operating costs. Going forward, with a stable outlook for air travel demand and jet fuel prices, gains from revised labor rates, less intense price competition and disciplined capacity addition will continue to benefit all airlines. From here stems the confidence of these airlines in their ability to sustain their profits and cash flows from operations in the coming years. Driven by this confidence, Delta, Southwest and Alaska have hiked their dividends and share buybacks this month.

In our view, this recovery in the airline industry could truly be different from previous short-term booms as all large airlines have through bankruptcies lowered their operating costs. Additionally, consolidation has reduced overall competition in the industry which is allowing individual airlines to raise fares more freely enabling them to book higher profits. If the demand environment and jet fuel prices hold steady in the coming years which is likely, then airlines will likely continue to post solid profits and we can see more airlines apart from Southwest, Delta and Alaska begin returning cash to their shareholders.

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Notes:
  1. Delta announces plan to return an additional $2.75 billion to investors through 2016, May 6 2014, www.delta.com []
  2. Alaska Air Group approves $650 million share repurchase program, May 12 2014, www.alaskaworld.com []
  3. Southwest Airlines returns value to shareholders, May 14 2014, www.swamedia.com []
  4. Delta’s 2013 10-K, February 2014, www.delta.com []
  5. Alaska’ s 2013 10-K, February 13 2014, www.alaskaworld.com []
  6. Southwest’s 2013 10-K, February 2014, www.swamedia.com []
  7. United’s 2014 Q1 earnings form 8-K, April 24 2014, www.unitedcontinentalholdings.com []