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Southwest Airlines

Southwest Airlines (LUV) announced that the dividend would be suspended due to the effects of COVID-19. The airline is arguably the best run airline in the U.S. based on its historic growth and investment grade credit rating. It has grown from a small regional airline to one that carries the most passengers in the U.S. The company has paid a dividend since 1989. The dividend has been raised for eight straight years since 2011 making the stock a Dividend Challenger. Southwest Airlines even made it through The Great Recession without its dividend being suspended. But the effects of COVID-19 are likely too much for Southwest and its dividend. On April 282020 Southwest Airlines announced that the dividend would be suspended until further notice. They also announced that share repurchases would be suspended until further notice.

Overview of Southwest Airlines

Southwest Airlines was founded in 1967 and is based in Dallas, TX. The airline operates a passenger air service in the U.S. and some international countries. At end of 2019, the company served 101 destinations in 40 states, Washington DC, Puerto Rico, Mexico, Jamaica, the Bahamas, Aruba, the Dominican Republic, Costa Rica, Belize, Cuba, the Cayman Islands, and Turks and Caicos. The company flies only Boeing 737 aircraft. It is also the largest airline by number of passenger carried. Total revenue was $16,611 million in 2019.

Southwest Airlines
Southwest Airlines Dividend Suspended

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Southwest Airlines Suspended the Dividend

Southwest Airlines paid a quarterly regular cash dividend of $0.18 per share giving an annual dividend of $0.72 per share. The dividend was growing at a double-digit rate of approximately 26% for the past 5-years. The dividend also had excellent safety metrics. The payout ratio was very low at roughly 21%. The combination of relatively high dividend growth rate, solid dividend safety from the perspective of earnings, and Southwest’s operational excellence made the stock a good dividend growth stock to own. However, COVID-19 essentially brought airline travel to a halt. The lack of revenue required Southwest to preserve liquidity and maintain a strong balance sheet. Besides other actions, Southwest accessed federal loans through the CARES Act Payroll Support Program or ‘PSP’ and also the secured loan program. But this source of funds came with stipulations about paying the dividend and hence, Southwest Airlines suspended the dividend.

Specifically, the company stated in the Q1 2020 earnings release:

During first quarter 2020, the Company returned $639 million to its Shareholders through the repurchase of $451 million of common stock and the payment of $188 million in dividends”… “The Company has suspended dividends and share repurchase programs until further notice.

In the Q1 2020 earnings call transcript, the CEO stated: 

The thing about the loan program is it carries, from your perspectives, it carries a lot of conditions. We can’t pay dividends during the time that the loan is outstanding plus a year, can’t do any share repurchases. You may not be as concerned about executive compensation, but it’s just another restriction on the company’s ability to manage.

So, the issue for Southwest is that the federal loan program requires them to stop paying the dividend during the time of the loan and then one additional year.

Impact of COVID-19 on Southwest Airlines

Demand for flights has plummeted due to COVID-19. On some days, at the depths of the impact of COVID-19, passenger flight demand was less than 10% of normal levels. I show select data from the Transportation Security Administration or ‘TSA’ to show the stark differences in traveler throughput through checkpoints in March through June or 2019 and 2020. You can check the site yourself to see the full dataset. This data is not exactly the same as demand for flights, but it serves as a proxy for that metric.

DateTotal Traveler ThroughputTotal Traveler Throughput (1 Year Ago – Same Weekday)
6/4/2020391,8822,623,947
6/3/2020304,4362,370,152
6/2/2020267,7422,247,421
6/1/2020353,2612,499,002
5/19/2020190,4772,312,727
5/18/2020244,1762,615,691
5/17/2020253,8072,620,276
4/12/202090,5102,446,801
4/13/2020102,1842,484,580
4/14/202087,5342,208,688
3/31/2020146,3482,026,256
3/15/20201,519,1922,545,742
3/1/20202,280,5522,301,439
Source: TSA checkpoint travel numbers for 2020 and 2019 (select data)

The need for infection control and ‘social distancing’ has meant that flights were not full. On average airlines were flying with about 90% fewer flights and severely reduced capacity since end of March 2020. Demand has picked up from end of April 2020 through early-June 2020. With that said we are still far from ‘normal’ levels for passenger demand and flights. Reportedly, U.S. airlines have parked 3,000 planes, which is more than 50% of the airplane fleet in aggregate.

In April 2020, which was when passenger tracked declined the most, Southwest’s load factor was approximately 8%. Operating revenues decreased 90% to 95%.

In May 2020 Southwest was expecting that capacity would be reduced by 60% – 70% and load factor improved to 25% – 30%, which is better than April 2020. In June 2020 it is expected that Southwest’s capacity will be half of the previous year, and load factor 35% – 45%. With such low demand, Southwest has been faced with empty seats despite the capacity cut. In turn this meant that Southwest was burning cash. In aggregate the airline industry was reportedly burning through $10 billion per month. Southwest is expecting that its cash burn rate in the second quarter to be $30 to $35 million per day, which is about $900 million to $1,050 million per month.

Southwest Airlines Builds Liquidity

The magnitude of the cash burn rate means that U.S. airlines as a group need to build liquidity and strengthen their balance sheets. As part of this Southwest Airlines increased access to short-term loans and notes and drew down its revolving credit line. At the end of Q1 2020, Southwest had approximately $5.5 billion in cash and short-term investments on the its balance sheet.  By mid-May 2020, Southwest had approximately $13.0 billion in cash and short-term investments on the balance sheet.

As part of the liquidity build, Southwest Airlines raised roughly $3.3 billion under the PSP. This included $2.3 billion in direct payroll support and $948 million in an unsecured 10-year term loan. Southwest also provided warrants for shares of common stock. As of the Q1 2020 earnings release, Southwest also intended to apply for another $2.8 billion in a secured loan.

The liquidity build was necessary. The PSP probably allowed Southwest to retain its employees for longer than expected to September 2020 considering the operating environment. But the money from the U.S. Treasury also came with the aforementioned conditions that led to Southwest Airlines dividend being suspended.

When Will Southwest’s Dividend Be Reinstated?

The natural question for many dividend growth investors is when will Southwest’s dividend be reinstated? Specifically, the agreement template states:

“Through September 30, 2021, the Recipient shall not pay dividends, or make any other capital distributions, with respect to the common stock (or equivalent equity interest) of the Recipient.” 

So, this means that dividends will not be reinstated until at least 16 months from now at the earliest from the perspective of the PSP agreement. However, from an operational perspective, the return of passengers to a level that allows Southwest to pay a dividend is not really known at the moment. Further, this is largely out of Southwest’s control.

Final Thoughts on Southwest Airlines Dividend Suspension

What does this mean for dividend growth investors? First, Southwest will not be a Dividend Challenger. The company will need another five years of dividend growth before being added to the list after the dividend is reinstated. Further, I think it is probable that the dividend is reinstated at a lower level than before the suspension. I do not think that airline travel will return to ‘normal’ or the numbers from before March 1st, 2020 in the foreseeable future. In any case, Southwest Airlines is no longer a dividend growth stock at this point.

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Thanks for reading Southwest Airlines (LUV): Dividend Suspended!

You can also read Rollins (ROL): The Dividend Cut was Disappointing.


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3 thoughts on “Southwest Airlines (LUV): Dividend Suspended

  1. “During first quarter 2020, the Company returned $639 million to its Shareholders through the repurchase of $451 million of common stock and the payment of $188 million in dividends… The Company has suspended dividends and share repurchase programs until further notice.” …does not appear to be a direct quote.

    1. It is taken from there earnings release. I indicated that it was from two different parts of her paragraph, but made it clearer.

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