On May 6, Delta Air Lines (NYSE:DAL) was grabbing investor attention as it announced a 50% increase in its dividend and a $2 billion share buyback. As airlines compete for investor dollars, its worth asking whether this Delta move could have a dividend ripple effect on the airline industry.
Last year, Delta launched a $500 million share buyback and a $0.06 quarterly dividend paying shareholders for the first time since it emerged from bankruptcy protection. Other airlines boosted their payouts following Delta's dividend reinstatement resulting in a quadrupling of Southwest Airlines' (NYSE:LUV) and Alaska Air Group's (NYSE:ALK) initiation of a dividend after years of share buybacks.
Since their initiation, airline dividends have shrunk in yield even as the airlines themselves have produced greater profits. But the shrinking yields result not from dividend cuts but from very strong share price performance, with the actual payout remaining the same. What started out as dividends in the 1.2%-1.3% range at Delta Air Lines and Southwest Airlines have shrunk to yields of less than 0.7%.
Capital return plan 2.0
Delta's latest plan looks to raise its dividend to generate a larger yield, although one still below last year's yield because of the massive share price appreciation. The $2 billion buyback is also well above previous levels, as Delta more than doubles down on a strategy to boost shareholder value.
Will other airlines respond with larger capital return plans of their own? Southwest Airlines essentially matched Delta's last dividend soon after the announcement was made, and Alaska Air Group wasn't far behind. Last year was a growth year for airline profits, so it's unclear how much of the dividend increases came from dividend envy and how much from decisions that would have been made anyway to return capital to shareholders. But with 2014 looking to bring more industry profit growth, the same factors could be at work again.
Dividends vs. buybacks
Especially notable in the Delta announcement is that while the dividend was increased 50%, the buyback program was quadrupled. For companies in an airline's position, choosing buybacks over dividends has a couple of key advantages.
First, airlines are in a good position for buybacks. Shares trade at reasonable valuations, there is not a pressing need for expansion capital as at many tech companies, and there is adequate cash available to reduce debt at the same time. The second advantage is one in long-term stability. While the airline industry has made notable improvements to protect itself for the economic slowdown, that doesn't mean airlines are now invincible from cyclical risks. Having adequate capital available to ride out an economic storm is important, and buybacks are preferred over dividends in this area. Unlike with cutting dividends, which sends a red flag and scares away investors, buybacks can generally be halted more quietly or simply not renewed.
If other airlines do boost their capital returns, look for greater returns on the buyback side than the dividend side as airlines seek to balance capital returns with long-term stability.
Changing the airline image
Airlines have been aggressively trying to shake off the image of over-indebtedness and low returns as they have grown their profits over the past few years. Becoming dividend stocks has helped airlines to show investors their own confidence in their futures while returning capital at the same time.
But airlines are also retaining a long-term outlook by utilizing share buybacks, which allow for greater flexibility in bad economic times than do dividends. So as Delta Air Lines boosts its capital return plan, airline investors should watch closely to see if other carriers follow.
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Alexander MacLennan owns shares of and has options on 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.