Are High-Flying Airline Stocks Cruising for a Fall?
In early May, Delta Air Lines (DAL) surprised the market by announcing it was boosting its distribution by 50 percent to 9 cents a share. The carrier's board also authorized a sweeping $2 billion share buyback plan, to be completed by the end of this year.
Delta's hike was a pleasant move that supported the stock price for the airline. But its shares had already been zooming to record altitude when the dividend hike was announced. The sector has never been a particular favorite of investors, so why -- outside of dividend news like Delta's -- has it been so popular lately?
The airline industry always has been, and always will be, a challenging place to make a buck. Regulations are stiff, expenses are high, and labor unions are powerful.
In spite of those headwinds, carriers have been doing very well in recent times. Much of this is due to developments around airlines' most burdensome expense: jet fuel.
For the most part, prices for fuel were down on a year-over-year basis in 2013; United Continental (UAL) saw its average price per gallon fall by 15 cents, to $3.12. Considering that the company burned roughly 4 billion gallons of the stuff, it adds up -- in this case, the savings amounted to $600 million.
This greatly helped the company to flip to a net profit in 2013 to the tune of $569 million on revenue of $38.3 billion. In the previous year, it recorded a loss of $723 million on revenue of $37.2 billion.
The same boost to the bottom line has been enjoyed by many carriers, "legacy" and budget operators alike. Aggressive discounter Spirit Airlines (SAVE) saw a net profit jump of 64 percent from fiscal 2012 to 2013. Southwest Airlines' (LUV) increase over that span was even more impressive, at just under 80 percent.
So a wave of optimism has spread through the industry, and carriers are feeling flush these days. And Delta wasn't the only company opening its coffers to make a shareholder-pleasing move.
One week after Delta's announcement, Alaska Air Group (ALK) announced a new $650 million stock buyback initiative -- around 10 percent of its current market capitalization, by the way. Meanwhile, the company hiked its dividend by 25 percent this past February, to 25 cents.
In mid-May, Southwest mirrored Delta by lifting its dividend by 50 percent (to 6 cents a share) and authorizing its own share repurchase scheme of up to $1 billion.
The recent happy developments mask a somewhat uncomfortable reality -- the airline business is a cyclical industry, with plenty of bust periods to go along with the booms.
%VIRTUAL-article-sponsoredlinks%Right now, the share prices of many carriers are at or near all-time highs, bringing into question whether those price levels are sustainable. An extreme example is Alaska Air Group, which this past April closed above $95 a share for the first time in its history. This from a stock that never drifted higher than $15 in its first 12 years on the exchange.
Another concern is those fuel prices. Yes, they've stayed relatively low in recent months, but will that last? The International Air Transport Association, the airline industry trade group, recently revised upward its forecast for the price of jet fuel to $108 a barrel for this year, from the previous $104.50.
As a result, the association shaved its expectation for the industry's overall profit for this year by $1 billion, to $18.7 billion.
An extra $3.50 a barrel, and the resulting $1 billion decline in profits, spread across the industry's many carriers aren't going to tank the operations of most airlines. But if they result in those companies falling short of the profitability levels the market expects of them, their stocks could very well see a sell-off from disappointed investors.
It follows, of course, that those pleasant dividends might come under fire if profitability is affected badly enough.
The airline industry is flying high for the moment. Investors in the sector should keep an eye on those costs, particularly fuel prices. It'd be wise to watch for any sign of wavering in those far-above-the-cloud-level stock prices, too.
Motley Fool contributor Eric Volkman has no position in any stocks mentioned. Nor does The Motley Fool.