Tax Cuts = Big Boost For Airlines And The Economy

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Includes: AAL, DAL, LUV, UAL
by: Vaughn Cordle, CFA

Summary

Airlines benefit from increased top and bottom line growth as individuals and businesses spend and invest more.

Faster airline capacity growth as airlines share increased earnings with consumers via lower fares.

Offshore cash flows back into the U.S., which in turn boosts investment and GDP growth.

Increased share repurchases and dividend payouts.

Increased capital expenditures and employee income.

Airlines will benefit from lower taxes in two ways: 1) Higher revenue as consumers and companies have more after-tax income/earnings to spend and 2) paying a lower corporate tax rate. Tax cuts boost economic growth when Americans and businesses have higher after-tax income. Individuals have more disposable income to spend, and businesses have more cash flow to invest, hire, and grow the business.

After the tax cuts, airlines that pay high [cash] taxes, such as Southwest (NYSE:LUV), will produce higher cash flows than network airlines like Delta (NYSE:DAL), American (NASDAQ:AAL), and United (NASDAQ:UAL), which will still work off NOLs (net operating loss) over the next several years. However, even the airlines that don't pay cash taxes will benefit from faster GDP growth since after-tax incomes/earnings increase for both consumers and businesses. Because the networks will eventually start paying cash taxes, they will also benefit from a lower corporate tax rate as cash flows increase in future years. This in turn increases the present value of those cash flows, which in turn increases shareholder value. Airlines will also increase share repurchases with part of the tax cut savings.

Tax cuts only represent one part of the fiscal policies proposed in the tax reform law. It doesn't take into account regulatory and welfare reform and the economic boost when some percentage of offshore cash is repatriated by U.S. companies. During Obama's time in office, U.S. companies doubled the amount of cash they shifted offshore which reduced investment and growth in the U.S. And job-killing regulation soared. Moreover, lower U.S. corporate tax rate will increase foreign investment in the U.S. A reduction of job and investment-killing regulations will boost economic growth up and above the growth derived from the tax cuts. Spending cuts have to be part of any comprehensive fiscal policy that boosts growth and changes the trajectory of debt and deficit spending. Moreover, there are some assumptions built into the government estimates that must be considered (inflates deficits via understating potential revenue). A detailed tax plan will be available once the House and Senate reconcile their plans...perhaps by next week.

If, as expected, the real GDP grows by an additional 30 basis points over the next several years, because of lower taxes, the top line airline industry revenue will grow by an additional 35 basis points (mid-point estimate). The growth multiple is greater than 1 when the economy is expanding, and less than one when contracting as it does at the end of a business cycle. An additional 30 basis points in growth, from 2.2% to 2.5%, may not sound like much. However, it represents a 13.6% increase in real growth.

Airline pre-tax earnings increase because the economy grows faster when consumers and businesses keep more of their income. Airline after-tax earnings increase because of lower tax rates. So, tax cuts provide airlines with a double benefit, boosting their bottom line (net earnings) by 20-30%, all else held constant. However, all else is rarely held constant. For example, airlines, especially lower-cost airlines like Southwest will pass along more of the tax savings to the consumer in the form of lower fares. So, my expectation is that airlines will keep roughly 50% of the lower tax savings (i.e., increased profits) as they attempt to grow market share faster than the competition. Of course, if one airline lowers its fares, typically all others are forced to follow suit and the consumer benefits. Lower fares result in higher passenger volumes and faster airline seat capacity growth. Higher growth boosts job growth and capital expenditures (e.g., aircraft sales), which in turn boosts economic growth. A positive feedback loop that benefits all stakeholders.

The bottom line is that individual after-tax incomes and corporate earnings increase with lower tax rates, and these boosts in disposable income and cash-flows will increase top- and bottom-line returns for the airline industry. Airlines will share additional cash flows and profits with employees via increased profit share and wage growth, and passengers will benefit from lower fares. Those who own the assets, the shareholders, will also benefit via increased share repurchases and earnings and so will the broader economy as more people can afford to fly. Furthermore, increased market values of corporate America increase the wealth effect, which results in additional spending. Hence the tax reductions are a win, win, win, and win for all stakeholders, including the broader economy and the middle class.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.