3 Airline Companies to Buy

Shweta is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Editor's Note: The article has been corrected to better reflect the United Airlines and Continental Airlines merger.

After the ill effects of surging oil prices and slow-paced world trade in 2012, the airline industry is finally showing positive signs of improved passenger traffic and freight volumes. This improvement is expected to be seen throughout this year. Such growth is reflected in the IATA's projections for the airline industry revenue to reach $671 billion this year from $637 billion last year.

Along with this rise, it is predicted that cost will increase to $649 billion from last year's $623 billion. This has led to a major challenge for airline companies of keeping revenue ahead of cost. Let’s find out what strategies these three airline companies are implementing to survive, protect, and grow their market share.

Future capital deployment and capital expenditure revealed

Delta Air Lines (NYSE: DAL) has investments in Virgin Atlantic, New York airports like LaGuardia and JFK, and it also has an investment in Trainer refinery. It expects growth in earnings from these investments and various cost-saving initiatives worth $1 billion in the coming years. The cash flow from operations is expected to improve such that the company anticipates cash flow of nearly $4 billion-$5 billion a year over the coming five years.

Delta plans to utilize half of the expected cash flow, $2 billion to $2.5 billion a year, on capital expenditure from 2014 to 2017. These funds will be re-invested on fleets, airport lounges, other products, and technology. Delta's net debt levels in 2009 were $17 billion. It was able to reduce it to $11 billion in the first quarter of 2013. The company now aims at reducing it to $10 billion by the end of this year, followed by reaching $7 billion over the next three to five years. This will also help the company in reducing its interest expense by nearly $500 million per year. Through such a restructuring strategy, it aims at achieving a BBB grade of investment rating, and it is a step to de-risk its balance sheet.

Delta plans to distribute cash to the shareholders in the form of dividends and a share repurchase plan worth $1 billion. One of the major reasons for such an initiative is that the company has posted profits for the past three years in a row and has reduced debt by $5 billion. It will pay a quarterly dividend of $0.06 per share in September 2013. With its first dividend payment this decade, it will buy back shares worth $500 million by mid-June 2016. In all, the company plans to generate $5 billion in value for investors as a part of its five-year plan.

Apart from Delta, Southwest Airlines (NYSE: LUV) is the only U.S. airline company which has announced dividends and share buyback plans. It has increased its share repurchase program by 50% and raised the dividend by four times. It will issue a dividend of $0.04 per share on June 26, 2013. It will repurchase shares worth $1.5 billion, of which $725 million has already been completed since August 2011.

The company posted cash and cash equivalents of approximately $3.5 billion in the first quarter of 2013. In the past two years, Southwest Airlines has returned cash to shareholders worth nearly $770 million, which is 20% of its operating cash flow, through dividend and share buybacks. From such a solid track record, investors can expect continuous distribution of cash from the company in the future also.

Focus on passenger segment and debt reduction

In 2012, United Continental Holdings (NYSE: UAL) lost a significant passenger traffic share to its competitors. This was mainly due to poor on-time performance, flight cancellations, and delays. It led to a 63% fall in the on-time arrival rate of the company in July. To overcome such operational issues, the company has set up an IT system, integration between United and Continental. This resulted in improvisation in its operations, leading to an 81% increase in its on-time performance in March 2013.

In addition, United reduced its flying capacity by 5% in the first quarter compared to last year. This flying capacity was reduced from markets like Trans-Atlantic, Europe, Domestic U.S., Latin America, and the Asia-Pacific. The reason for this decline in flying capacity was to reduce the number of empty seats on its flights. This has improved the occupancy rates of the airline to 81.1% in the first quarter of 2013, compared year over year. By the end of this year, it plans to reduce its flying capacity by 0.75% to 1.75% on an annual basis.

In order to increase the passenger traffic, United is focusing on providing better customer service to improve the flyers' experiences with the airline. It includes an in-flight Wi-Fi facility, flat-bed seats in premium class, live television in more than 200 aircrafts, and more legroom in economy seating. These factors will help United in regaining the lost passenger share from its competitors and boost the revenue of the airline, as the passenger segment contributes 86.68% to the total revenue of the company.

Also, United is focusing on reducing its debt. Through the past four years, it has been able to bring down its debt by $8 billion, which includes low-quality and high-interest debt. The debt taken on during the merger with Continental has also decreased to $12.1 billion as of March 2013, compared to $15.1 billion at the end of 2010. This activity will bring down the interest payments to $700 million by this year, from $1 billion in 2010.

United also aims at paying off the 6.75% notes worth $800 million, due in 2015. It will settle this debt in October 2014, as they are pre-payable from this period. This will further help the company in stabilizing the amortization schedule in the future.

Henceforth, United will benefit from these debt payments, which will result in reduced risk in the business, along with increment in earnings through reduced interest payments.

Conclusion

This time, Delta has well worked out its strategies, keeping in mind the interests of investors. With reducing debt and cash distribution, Delta has improved its financial position.

Southwest Airlines provides periodical distribution of cash to its shareholders through dividends and share repurchase programs.

United has planned its strategies well to attract the passengers it lost to its competitors last year with a range of services and reduction in debt.

I suggest buying all three stocks.

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Shweta Dubey has no position in any stocks mentioned. The Motley Fool recommends Southwest Airlines. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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