There’s a Wall Street joke that basically goes, “What’s the easiest way to watch your investment go up in flames? Light it directly on fire or buy an airline stock.” Well, the joke may be on people who came up with the saying. Barring some one-off mishaps – like the one that recently embroiled United Airlines – airlines may still be investment-worthy as they try to improve their reputation on Wall Street.
Profitability is finally here for many larger-scale carriers, M&A activity continues to rise and airline stocks are finally doing something that they never really were able to do before: pay dividends and buyback tons of stock.
And it looks like the airlines should be able to keep up with their recent success.
For investors, the sector isn’t without risk; these are airlines, remember? But it does offer an interesting play on the beginnings of a new dividend growth industry — one that could pay benefits over the long haul, if things keep up.
Welcome to Bizarro World
What a difference a decade makes. Hopping into our time machine and traveling back to 2000-ish, the airlines were facing a much different environment. High fuel costs, the September 11 terrorist attacks and other issues hit them hard, and cost-cutting measures weren’t enough to handle the pressures. Some of the biggest carriers — Delta Air Lines (DAL ), United Airlines and American Airlines — as well as smaller regional airlines, kicked off a wave of bankruptcies.
But that was then, and this is now.
Today’s airlines are profit-making machines. The International Air Transport Association (IATA) estimates that North American airlines will produce profits of $22.9 billion this year. Although this is an almost 10.8% decline over 2016 estimates, North American carriers are expected to show the strongest financial performance globally in 2017.
Driving those profits have been a combination of factors. For starters, the crash in oil prices has meant that the high cost for jet fuel is gone. Considering this is the sector’s number-one cost, that’s huge. Also benefiting the airlines have been increased fees. All those baggage, check-in and other fees that were enacted to help cushion the effects of high fuel prices are still around, despite the falling prices. That’s an added boost for the airlines’ bottom lines.
Finally, travel traffic, both business and leisure, has continued to increase as the economy has expanded, and consumers feel better about their prospects. For instance, in North America, 2016 saw a 2.6% increase in demand for international passenger traffic.
All of this has driven profitability at the major airlines. In fact, a number of them had their best years ever during the past 24 months.
Adding More Cash Back to Investors
After not paying even pennies in dividends during the years leading up to the financial crisis, the return to profitability has the airlines opening up their wallets today. They simply have better balance sheets, better pricing power and sounder financial situations.
As a result, the group returned more than $10 billion back to shareholders via dividends and buybacks last year — a feat unheard of before.
And they are still growing those payouts. Last year, Delta Air Lines increased its dividend by 50%, Southwest Airlines (LUV ) hiked its payout by around 30%, and Alaska Air Group (ALK) boosted its payout by 38% at the start of the year. Heck, even small carriers such as SkyWest (SKYW) managed to show meaningful dividend increase of 12.5%.
Buying the Airlines
Given the backdrop for continued profitability and rising demand, the airlines are shaping up to be some pretty impressive dividend growth plays. Headline yields for regional airlines are still pretty low, averaging around 0.87%. These aren’t current income plays. But the 15% to 50% in dividend growth is nothing to sneeze at. And as we know, the growth of dividends is what counts over the long haul. With the current positive environment, the airlines should be able to keep minting cash for the foreseeable future.
For investors, that means finally buying the airlines.
The U.S. Global Jets ETF (JETS ) offers a broad play on the theme, offering exposure to roughly 34 top airlines stocks. The ETF is global in focus, but that shouldn’t dissuade dividend investors. Many international airlines are also catching dividend fever. According to its half-year-result announcement in February 2017, Australia’s Qantas, which hiked its dividend last year, continues to pay dividends. Again, the JETS yield isn’t very high (currently at 0.57%) on its own, but it should grow as more airlines hand over their cash.
In terms of direct plays, both DAL and LUV have what it takes to keep on giving the goods. During the last two years, both companies ensured decent operating profits. In addition, both maintain a low payout ratio in the range of 10% to 16%. That leaves a ton of room for future increases. Meanwhile, traffic across both of their systems remains very robust, which helps. DAL and LUV yield 1.8% and 0.72%, respectively. Again, the key is dividend growth.
Speaking of that growth, starting at zero and initiating a dividend could also be quite powerful. United Continental Holdings, Inc. (UAL) which has already jumped on the buyback train, can be a potential candidate to start paying dividends in the coming years. However, UAL is likely to face stiff competition not only from DAL but also from regional giants like LUV. Moreover, the company needs to learn from its recent public relations mishap surrounding overbooking issue, leading to a 1.13% drop in share price and wiping out just over $250 million in market capitalization.
Flying the Friendly Skies
After years of being Wall Street’s joke, the airlines are quickly becoming dividend royalty. The growth in payouts has been tremendous in recent years as profits continue to roll in. They aren’t the highest yielders, but they could be some of the fastest as sector trends continue. The time to buy the airlines could finally be here.
