Can Southwest Airlines Outperform Against Economic Headwinds?

Southwest Airlines Co. (NYSE:LUV) is one of the only major U.S. carriers to escape the financial crisis without filing for bankruptcy. With shares trading around $10.12, is LUV an OUTPERFORM, a WAIT AND SEE, or a STAY AWAY? Let’s analyze the stock with the relevant sections of our CHEAT SHEET investing framework:

T = Technicals on the Stock Chart are Strong

The stock price was recently 8.33 percent above its 20-day simple moving average, or SMA; 11.45 percent above its 50-day SMA; and 14.88 percent its 200-day SMA.

Since the beginning of 2012 the stock price has been in a fairly pronounced upward trend, rising 15.36 percent this year-to-date and rising 15.09 percent year-over-year.

As a benchmark, the S&P 500 has risen 13.54 percent year-to-date and has risen 13.75 percent year-over-year.

E = Earnings are Unsteady

Southwest has posted revenue gains in three of the last four years. Revenue dropped 6.11 percent in 2009 after the financial crisis, but climbed nearly 17 percent in 2010, and nearly 30 percent in 2011.

Fiscal Year 2007 2008 2009 2010 2011
Revenue ($) in millions 9,861 11,020 10,350 12,100 15,660
Diluted EPS ($) 0.84 0.24 0.13 0.61 0.23

 

Earnings, on the other hand, have decreased in three of the last four quarters. Like every other airline on the planet, the company has faced tremendous economic headwinds and is highly sensitive to fuel prices, which have not helped its bottom line…

The company’s quarter-over-quarter performance over the last five periods is also slightly unattractive. Southwest did post a 15.6 percent revenue jump in the June (second) quarter, but was slightly worse off in September of 2012 than in 2011.

Quarter Sep. 30, 2011 Dec. 31, 2011 Mar. 31, 2012 Jun. 30, 2012 Sep. 30, 2012
Revenue ($) in millions 4,311 4,108 3,991 4,616 4,309
Diluted EPS ($) (0.18) 0.19 0.13 0.30 0.02

 

Year-over-year earnings for the third quarter were a solid beat, if still barely positive. Third-quarter net income was heavily impacted by $81 million in unfavorable special items, without which earnings would have been $0.13 per diluted share.

E = Excellent Poor Performance Relative to Peers

Many investors favor return on equity as a key metric to diagnose how well a company is performing. Unfortunately, Southwest’s operational performance compares unfavorably to its competitors. LUV has an ROE of 7.34 percent, compared to Delta Air Lines Inc. (NYSE:DAL) with an ROE currently at a whopping 234.27 percent, and JetBlue Airways Corporation (NASDAQ:JBLU), which has an ROE of 8.31 percent.

Operating margins are also critical for stock evaluation. On this metric, Southwest stacks up unfavorably to its competitors with a margin of 3.99 percent. This compares to Delta with a margin of 6.88 percent, and JetBlue with a margin of 8.41 percent.

However, Southwest’s low margins are indicative of its status as a low-cost carrier…

T = Trends Suggest that the Airline Industry is ExpensiveSouthwest Wing

At the beginning of November, Airlines for America published a report on the status of the airline industry for the year to date. The report points out that while revenues rose an average of 5.6 percent, costs increased at a faster rate and reduced profit margins to just 0.2 percent across the industry.

Fuel accounted for 34 percent of operating expenses across the industry for the first nine months of 2012. The average price per gallon of Gulf Coast jet fuel was $3.08. For some perspective, the cost of fuel averaged just $1.02 per gallon between 2001 and 2005, $2.17 between 2006 and 2010, and $3.00 in 2011.

Gary C. Kelly, chairman of the board, president, and CEO of Southwest stated in the company’s third-quarter earnings: “Third quarter 2012 economic fuel costs were $3.16 per gallon, which was in line with third quarter 2011. Crude oil and jet fuel prices have soared over the last several months, and our fourth quarter 2012 economic fuel costs are expected to hit an all-time high $3.45 per gallon (based on market prices as of October 15, 2012). This is disappointing, especially given the weak economy, and we will need to more aggressively control costs in the next year.”

Conclusion

Southwest’s growth over the last year has been strong yet modest, beating out the S&P by a few percentage points but trailing some of its competitors. Twelve analysts maintain an average price target that is just about $1.30 higher than its closing price on December 11, and a fairly emphatic “Hold” consensus.

Because of this, and the metrics mentioned above, Southwest is a WAIT AND SEE. Investors who want to put their money to work should look for companies with stronger growth potential.

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