Since earlier this summer, shares of Delta Air Lines (NYSE:DAL) and American Airlines Group (NASDAQ:AAL) are down 7% and 17%, respectively, from their highs. But there are several reasons that this dip is actually an excellent buying opportunity for value investors.
Lower oil prices
Airline stocks were on a steady flight upward through early 2014, but their ascent was halted in early June as oil prices spiked. Because of supply concerns stemming from geopolitical concerns, Brent crude topped $112 a barrel, and West Texas Intermediate Crude topped $105 a barrel.
This oil price spike marked the record high for Delta Air Lines stock and put a ceiling on American Airlines Group stock that kept it from topping $45 per share.
But while these airline stocks fell and have yet to recover, oil has fallen well below its pre-spike heights. Thanks to rising supplies, lagging demand, and a rise in the U.S. dollar, oil prices are now well below where they started the year, with Brent crude now at $98 a barrel, and West Texas Intermediate crude at $92 a barrel.
While investors sold off these airlines over fuel cost concerns, they have yet to buy back in now that fuel costs are not only below the pre-spike price, but below the beginning of the year price.
Overblown traffic results concerns
Admittedly, traffic numbers from airlines have not been great, but they're far from terrible. August PRASM numbers from Delta Air Lines came in with a 2% gain -- compared to a guided 2% to 3% gain -- but Delta noted the results were affected negatively by "events in Russia, the Middle East and Africa." August traffic numbers from American Airlines Group came in with flat revenue passenger mile numbers and a slight slip in load factor.
Delta's September PRASM guidance was reduced from a 2-4% gain to a 2-3% gain. However, Delta's and American's margin guidance remains strong, and at least part of these traffic results came from geopolitical issues that airlines may be able to work around in the near future.
Even lower valuations
The airline rally through 2013 and early 2014 came largely from investors recognizing the lower valuations of airline stocks and beginning to move them toward a more reasonable valuation. But even at their peaks, Delta Air Lines traded at only 12 times FY2015 earnings, and American Airlines Group traded at only 8 times FY2015 earnings.
Not only do the lower stock prices make the shares cheaper compared to these June estimates, but the estimates themselves have risen as well, with American's FY2015 estimates increasing 12% since June, and Delta's FY2015 estimates increasing 8% since June.
In a market many investors consider overvalued, shares of Delta Air Lines, American Airlines Group, and most other airlines trade well below the market average. If airline valuations can move closer to the market average, value investors could be rewarded by choosing airline stocks.
Dividends and buybacks
While it's important airlines don't get too far ahead of themselves when it comes to returning cash to shareholders, today's levels of dividends and buybacks achieve shareholder value objectives without threatening the financial stability of these carriers.
Last year, Delta Air Lines launched a $500 million stock buyback and a $0.06 per quarter dividend, becoming the first major legacy airline to reinstate these policies. But the capital return plan was given a boost this year when the buyback was increased to $2 billion and the dividend raised to $0.09 per quarter.
American Airlines Group also announced a $1 billion stock buyback coupled with a $0.10 per quarter dividend, marking the first time American Airlines has paid a dividend since 1980.
With airline stocks trading at such low valuations, these buybacks could go a long way to increasing earnings per share. In fact, the recent dip in airline stocks may serve to benefit shareholders in the long run since the lower current share prices allow airlines to buy back more shares for the same price.
Although the dividends from Delta and American Airlines are not nearly enough to make these companies into income stocks, they do serve a purpose besides the amount actually paid to shareholders. By paying a dividend, shares of these airlines can now be purchased by dividend-only funds, and by investors with a strategy of only purchasing dividend-paying stocks. While this type of buying in is wearing off for Delta, the more recent dividend reinstatement from American Airlines could bring more big money investors to the stock.
Analysts and big money are still on board
Even as these airline stocks have dipped and the traffic reports have scared off some investors, analyst earnings estimates for FY2015 have risen for all four major airlines. Target prices have also increased for Delta Air Lines, and barely slipped for American Airlines Group.
Institutional investors are also getting on board with net buyers during the last three months for both Delta Air Lines and American Airlines Group. While you should not blindly follow analysts and big money investors, having them remain bullish is still a positive for the stock.
Delta Air Lines and American Airlines Group appear to be attractive buys after a slide in their respective stock prices. While airlines still carry above-average risks, there are several reasons to be bullish on airline stocks after this dip. Risk-tolerant investors should consider whether these companies fit with their overall investment strategy.
Alexander MacLennan owns shares of AMERICAN AIRLINES GROUP INC and Delta Air Lines. Alexander MacLennan has the following options: long January 2015 $22 calls on Delta Air Lines, long January 2015 $25 calls on Delta Air Lines, long January 2015 $30 calls on Delta Air Lines, long January 2015 $17 calls on AMERICAN AIRLINES GROUP INC, long January 2015 $32 calls on AMERICAN AIRLINES GROUP INC, and long January 2015 $40 calls on AMERICAN AIRLINES GROUP INC. 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 may not 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.