Will Southwest's Dividend Take Off

By Jonathan Yates - July 9, 2012 | Tickers: BAC, SPY, LUV, UAL, LCC | 0 Comments

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While Southwest Airlines (NYSE: LUV) always ranks high in customer service, the performance of its stock for shareholders has not been one of great satisfaction.  Now trading around $9.30 a share, Southwest Airlines is well below its 5-year high of about $16.20.  Over the last 52 weeks of market action, Southwest Airlines is off by more than 18%.

In so many different ways, Southwest Airlines treats its customers so much better than other passenger carriers.  There are no baggage fees.  Travel plans can be changed without the $150 penalty that US Airways (NYSE: LCC) charges.  Its frequent flier program, Rapid Rewards, is far more user friendly in every possible way.

To further separate itself from other airlines and reward its shareholders, Southwest Airlines should raise its dividend.  Unlike other air carriers, Southwest Airlines does pay a dividend.  However, the yield is only 0.43%, four cents a year.  The average dividend for a stock on the Standard & Poor's 500 Index as approximated by the SPDR S&P 500 (NYSEMKT: SPY) is around 2%.  Even Bank of America (NYSE: BAC), the Dow Jones Industrial Average member with the lowest yield, at 0.50%, pays a higher dividend than that of Southwest Airlines.

Southwest Airlines has plenty of cash.  The price-to-cash per share ratio is 1.88.  The price-to-free cash flow ratio is 12.01.  Already healthy, the cash position of Southwest Airlines should improve for a variety of factors in the very near future.

A major reason is that the $1.4 billion acquisition of AirTran should start yielding profits soon.  Unprofitable routes acquired from AirTran have been closed and planes that do not fit into the fleet of Southwest Airlines have been leased to others.  Southwest Airlines also just won its bid, beating back opposition from United-Continental, to fly 25 daily, lucrative international routes from Houston Hobby Airport.  For next year, earnings-per-share growth is expected to be 39.24%.  On a quarterly basis, sales growth is higher by 28.62%; with the present price-to-sales ratio at just 0.43.  The forward price-to-earnings ratio for Southwest Airlines is projected to be 8.44.

Unlike many other airlines, Southwest Airlines has a relatively clean balance sheet.  US Airways has a debt-to-equity ratio of 22.19.  United-Continental (NYSE: UAL) has a debt-to-equity ratio of 8.24.  The debt-to-equity ratio of Southwest Airlines is a modest 0.47.

Increasing its dividend would also contour Southwest Airlines' stock with the new realties of the marketplace.   Individual shareholders are now demanding more dividend income.  Institutional investors seeking substantial dividend yields would be more attracted.  With growth flat in the stock markets for more than a decade, dividend income has become even more critical.  This is nothing new, however.  According to legendary investor John Neff, founder of Vanguard and creator of the first index mutual fund, in his book, Enough, more than 40% of the historic total return of an equity has been from the dividend component.

Southwest Airlines has been profitable for 39 consecutive years.  To provide additional context, there have been more than 300 bankruptcies in the airlines industry since deregulation in 1978.  Despite that, Southwest Airlines is up just 8.54% for 2012.  By contrast, US Airways has risen by 160.55% for the same period.  Year to date, United-Continental has risen by 27.61%.  Increasing its diviend will further contrast Southwest Airlines from its competitors and make the stock more attractive.

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