Southwest Airlines: Invest Or Avoid?

Southwest Airlines (LUV) has been a dominant player in the airline industry for over five decades. The company has a strong reputation for providing quality, low-cost services and an unwavering commitment to its workers. While the airline industry has been severely impacted by the pandemic, Southwest Airlines is better positioned than most other airline companies. The company ended 2020 with $14.3 billion in available liquidity, including cash and debt, and a strong balance sheet will allow Southwest to withstand a volatile macro environment.

Southwest Airlines stock has experienced a significant amount of volatility in recent months, but it has also been attracting investors' interest. The stock is currently trading at around $26, with a market cap of $36 billion. Analysts have given the stock a moderate buy rating, and the consensus view is that it is undervalued.

However, it's important to remember that Southwest Airlines, like other airlines, faces challenges due to the impact of the pandemic on travel demand and restrictions on global travel. The company expects to burn $17 million each day in the first quarter of 2021. Additionally, Southwest faced significant cancellations during the 2022 holiday season, which may have impacted customer confidence.

Overall, Southwest Airlines' robust business practices, strong financial position, and focus on the domestic market make it an attractive investment option for both short-term traders and long-term investors.

Southwest Airlines' stock price and valuation

Southwest Airlines Stock Price and Valuation

Overview

Southwest Airlines Co. (NYSE: LUV) has been a major player in the airline industry for over five decades. The company operates a fleet of 817 Boeing 737 aircraft, serving 121 destinations across the US, Puerto Rico, and several near-international markets. With a focus on efficient business practices, Southwest has built a reputation for providing quality, low-cost services.

Stock Price

As of May 2024, Southwest Airlines stock was trading at around $31.63 per share, a significant dip from its previous value. This drop presents a potential buying opportunity for investors.

Valuation and Analyst Ratings

Southwest Airlines is currently rated as a Zacks Rank 5, indicating a below-average return relative to the market in the short term. However, valuation metrics suggest that the stock may be undervalued. It has a Value Score of B, making it a good pick for value investors. The company's strong financial health and growth prospects, including its efficient business model and robust liquidity position, make it an attractive recovery stock.

Analysts at Yahoo Finance and MarketBeat have given Southwest a "buy" and "moderate buy" rating, respectively. The consensus view is that the stock is undervalued, presenting an opportunity for short-term traders.

Business Fundamentals

Southwest Airlines has a strong balance sheet and a history of profitable operations, with 47 consecutive quarters of profitability before the pandemic. The company reported a steep decline in revenue in Q4 2020, with an operating revenue fall of 65% year-over-year and a total loss of $3.5 billion. However, Southwest ended the year with $14.3 billion in available liquidity, positioning it well to withstand a volatile macro environment.

Risks and Challenges

Investing in airline stocks comes with risks. The airline industry has faced significant challenges due to the pandemic, and Southwest was not immune, with a substantial loss in 2020. Additionally, the company faced criticism and customer backlash due to a high number of flight cancellations during the 2022 holiday season.

Furthermore, the airline industry is capital-intensive, and companies continue to burn cash due to tepid demand and travel restrictions. Southwest Airlines expects to burn $17 million per day in the first quarter of 2021.

Opportunities

Despite the challenges, there are positive signs for Southwest Airlines. The rollout of vaccines and the potential increase in travel demand, especially in the domestic market, could boost the company's performance. Southwest's focus on the domestic market and expansion into smaller leisure destinations may help offset the decline in international travel.

Additionally, government aid and relief packages, such as the $1.9 trillion relief package, provide further support for the industry.

Southwest Airlines' robust business fundamentals, strong liquidity position, and potential for a post-pandemic recovery make it an attractive investment option. However, investors should carefully consider the risks and challenges facing the airline industry before making any investment decisions.

The company's financial health and business model

Southwest Airlines' business model is based on low-cost pricing and efficient operations. The company focuses on offering the lowest prices for the most popular routes and has fewer aircraft types, services in smaller airports, and high airplane utilization, with short-haul flights and quick turnarounds. This strategy has allowed Southwest Airlines to become the leading low-cost airline in the United States, with flights to over 90 destinations, including the Caribbean, Central America, and Mexico.

The company's financial health appears strong, with a robust balance sheet and liquidity position. Despite the challenges faced by the airline industry during the pandemic, Southwest Airlines ended 2020 with $14.3 billion in available liquidity, including cash and debt. The company's long-term financial performance also demonstrates its stability, with 47 consecutive years of profitability before the pandemic.

Southwest Airlines' revenue streams are primarily derived from passenger revenue, freight revenue, and other services such as early check-in and in-flight sales. The company's cost structure includes fleet operation and maintenance, fuel, personnel, marketing, sales, and administrative expenses.

The airline's flexible business model and focus on cost control have contributed to its financial health. Southwest Airlines has a track record of forward-thinking and adaptability, which has helped it navigate economic downturns and industry disruptions. The company's commitment to low-cost operations and efficient processes has positioned it well to withstand challenging market conditions.

In summary, Southwest Airlines' financial health and business model appear robust and well-suited to the dynamic nature of the airline industry. The company's low-cost strategy, efficient operations, and strong financial position make it a stable investment option in the airline sector.

The impact of the pandemic on the airline industry

The COVID-19 pandemic has had a significant impact on the airline industry, with travel restrictions and a decimation in traveller demand causing revenue to plummet. In the first quarter of 2020, the number of flights dropped dramatically, with about 280,000 flights reported between 24 and 30 March 2020 compared to around 780,000 in a similar period the previous year.

The pandemic has wreaked financial devastation across the aviation value chain, but most notably for airlines. In 2020, airlines haemorrhaged $168 billion in economic losses. This was due to a combination of the pandemic-induced plunge in passenger traffic and the industry's underlying and long-term health problems.

The pandemic has also exposed the inherent challenges in the business models of most airports: high fixed costs and mainly variable revenue flows. Dwindling traffic led to heavy economic losses of $32 billion, or 45%, in 2020.

The sole bright spots are the freight forwarder and air cargo subsectors. In 2020, both managed to generate healthy economic profits: for freight forwarders, 4%; and air cargo carriers, 9%. In fact, the only five airlines that reaped profits in 2020—AirBridgeCargo, Atlas Air, Cargojet, Cargolux, and Kalitta—were cargo carriers.

The impact of the pandemic on the industry has been long-lasting. As of the third quarter of 2020, China Southern became the first of the large Chinese carriers to return to profitability, while Air China and China Eastern managed to narrow their losses, helped by domestic travel recovery. By May 2021, 7,850 airliners were still in storage, down from a peak of 16,522 in April 2020.

By the end of 2021, the global airline industry had returned to 79% of its pre-Covid size. In the final quarter of 2022, the industry was at 105% of the 2019 activity: 84% of passenger numbers with higher fares due to strong demand and constrained capacity, 97% of the fleet size, and 92% of the employee number.

Pros and cons of investing in airline stocks

Pros:

• Diversification: Airline ETFs provide investors with diversification by holding a basket of airline stocks. This diversification helps mitigate the risks associated with investing in individual airline companies.
• Industry exposure: Airline stocks offer investors exposure to the airline industry as a whole, allowing them to benefit from the sector's potential growth and resilience.
• Convenience and accessibility: ETFs are traded on stock exchanges and can be bought and sold throughout the trading day, providing flexibility and liquidity.
• Cost efficiency: Airline ETFs generally have lower expense ratios than actively managed funds, making them an attractive option for investors seeking affordable investment opportunities.
• Professional management: ETFs are managed by experienced professionals, saving investors time and effort in researching and selecting individual airline stocks.
• Liquidity: Airline ETFs typically have higher trading volumes, translating into greater liquidity and flexibility for investors.
• Risk mitigation: By diversifying across multiple airlines, investors in airline ETFs can reduce the impact of negative events specific to a particular company.
• Dividends: Some airline ETFs distribute dividends, providing a potential income stream for investors.

Cons:

• Industry volatility: The airline industry is susceptible to fuel prices, geopolitical events, economic conditions, and regulatory changes, resulting in potential fluctuations in investment value.
• Economic sensitivity: Demand for air travel tends to decline during economic downturns, affecting airline revenues and profitability, which can impact the performance of airline stocks.
• Company-specific risks: Airline ETFs carry company-specific risks, such as labor disputes, rising operating costs, management issues, or competitive pressures, which can significantly impact the ETF's performance.
• Regulatory and political factors: Changes in air travel regulations, government policies, or political events can affect the industry and the performance of airline stocks.
• Concentrated exposure: While providing diversification, airline ETFs may have a significant portion of their holdings concentrated in a few major airlines, increasing the impact of challenges faced by these airlines.
• Lack of control: Investing in ETFs means investors relinquish direct control over individual investment decisions as fund managers make choices about the ETF's holdings.
• Fees and expenses: Airline ETFs come with fees and expenses that can reduce net returns for investors over time.
• Market risk: Airline ETFs, like any investment, are subject to general market risks, including fluctuations in stock prices, interest rates, and overall market sentiment.

Analyst ratings and recommendations

Despite the recent dip in its stock price, Southwest Airlines is considered a good investment by many analysts. As of early April 2023, the consensus view was that Southwest Airlines is a "buy," supported by its strong business fundamentals, its dominant position in the air travel market, and its history of robust growth. Yahoo Finance and MarketBeat have both rated the stock as a "buy" or "moderate buy." The current analyst consensus for the stock price is $47.07, representing a potential increase of nearly 50% from its current price.

Southwest Airlines has several strengths that make it an attractive investment option. These include efficient and cost-cutting business practices, a strong balance sheet, healthy profit margins, and consistent year-over-year operating revenue growth. Additionally, the company has a strong reputation for providing quality, low-cost services and for its commitment to its workers, even during financial crises.

However, it's important to remember that analyst projections are based on mathematical models and educated guesswork, and predicting stock prices with 100% accuracy is impossible. Southwest Airlines may not be a good choice for investors seeking dividend-yielding stocks, as its dividend yield has historically hovered just over 2%. Furthermore, the airline industry as a whole faces challenges due to the impact of the COVID-19 pandemic and other factors, and some analysts caution against investing in airline stocks due to their high operating costs and limited opportunities for differentiation.

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