Last year was a strong one for airlines and their stocks, with both earnings and share prices soaring, in some cases to record highs. The year was also met with new returns of capital to shareholders, as more airlines became dividend stocks. But will this trend continue, which airlines will join, and how will these airlines go about their plans?
The dividend year
Airlines are not traditionally known as dividend-paying businesses, and years of tough competition and economic troubles have forced airlines to keep every penny they bring in. But 2013 saw the beginning of dividends by Delta Air Lines (NYSE:DAL) and Alaska Air Group (NYSE:ALK), as well as the quadrupling of the dividend at Southwest Airlines (NYSE:LUV).
Profits across the industry surged and future outlooks improved, making paying dividends possible again. While these dividends still generate relatively small yields, investors are curious about which other airlines will follow this trend.
The other big carriers
Among the legacy carriers, Delta Air Lines is the only one that pays a dividend, but it's worth examining the dividend potential at other large carriers. United Continental (NYSE:UAL) has noted the potential to begin paying a dividend, saying that earnings increases will help "to generate sufficient cash to begin allocating capital to shareholders by 2015."
American Airlines Group (NASDAQ:AAL) is another story in itself. Late last year, the official papers were signed to merge US Airways and American Airlines parent company AMR to create American Airlines Group. However, the job of integrating two major airlines will take years and will be the primary focus of this airline. (I discuss this issue further in this article.)
American Airlines Group is also on an aircraft buying spree. as the carrier seeks to cut fuel costs and build a new image through fleet renewal. This decision will use up much of the airline's spare cash. limiting options for other shareholder initiatives. The combination of aggressive fleet renewal and the merger integration leads me to believe American Airlines Group won't issue a dividend for several years as the carrier reinvests in itself.
While some airlines do pay dividends, these are clearly not high-yield investments. Both Delta's and Southwest's dividends are less than 1%, and Alaska's is only 1.01%. To be fair, these were higher yields before the rally over the latter part of 2013, but even then yields were still less than 2%.
It's not surprising why airline dividends have low yields. Airlines are hugely capital-intensive businesses and are often accompanied by high debt levels.
Although airlines aren't known as star dividend payers, they are getting into the share-buyback game. Before initiating a dividend, Alaska Air Group bought back hundreds of millions of dollars in shares, and Delta's current dividend is part of a larger plan that also includes $500 million in buybacks.
Share buybacks have their pros and cons, but I see them as a smart alternative to large dividends at airlines. Unlike dividends, which investors expect to run forever and which can raise red flags any time the payout is cut, buybacks can be turned on or off depending on market conditions. By using buybacks to grow shareholder value as opposed to larger dividends, airlines retain more flexibility to retain cash if fortunes turn sour for the industry again.
Airlines have rewarded shareholders in 2013 enough with capital gains alone. But the companies are eager to use their good fortune to pay dividends and issue buybacks as well. While I see American Airlines Group as unlikely to begin a dividend in the near future, United Continental may join the dividend club in 2015 if market conditions continue to improve.
Strong companies with growing dividends
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Alexander MacLennan owns shares of and has options on American Airlines Group and Delta Air Lines. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.