Should Investors LUV Southwest?

With shares of Southwest Airlines Co. (NYSE:LUV) trading at around $13.04, is LUV an OUTPERFORM, WAIT AND SEE or STAY AWAY? Let’s analyze the stock with the relevant sections of our CHEAT SHEET investing framework:

C = Catalyst for the Stock’s Movement

Why are more people flying Southwest? Word-of-mouth certainly has something to do with it. New features have also played a role, including EarlyBird Check-in and All-New Rapid Rewards. However, the overall experience is the biggest factor.

There are several ways to see how happy travelers are with an airline. One such method is to look at satisfaction ratings on TripAdvisor.com. Southwest has an impressive satisfaction rating of 93 percent. The only other airline that comes close to such a high rating is JetBlue Airways Corporation (NASDAQ:JBLU), which has a satisfaction rating of 91 percent. Delta Air Lines Inc. (NYSE:DAL) has a decent 63 percent satisfaction rating, and United Continental Holdings (NYSE:UAL) has a subpar 46 percent satisfaction rating.

In addition to satisfying customers, Southwest also saw increased traffic last month. Revenue Passenger Miles came in at $9.44 billion, which was a 4 percent increase year-over-year. Consolidated Capacity increased 3.8 percent year-over-year, and Load Factor was 82.0 percent compared to 81.8 percent last year. Looking at a bigger picture, Revenue Passenger Miles are up 0.3 percent year-to-date. This isn’t a big improvement, but it’s better than a decline.

When it comes to the bottom line, the biggest factor for the airlines is fuel costs. Some airlines are doing their best to cut these costs in very innovative ways. These measures must be taken because fuel is a double-edged sword. If the economy is doing well and demand is high, then fuel costs will also be high. This cuts into profits. If the economy is doing poorly, then fuel costs decrease, but so does demand. In this situation, the airlines must do everything possible to improve their bottom lines. Part of the reason the airlines have performed so well over the past several years is because fuel has remained steady while demand has increased. This is a unique environment. Unfortunately, it’s not an environment that’s likely to last. The good news is that airlines like Southwest, Delta, and JetBlue are making many moves to reduce fuel costs. In other words, they’re not only cutting costs now, but they’re preparing for the future.

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Now let’s take a look at some comparative numbers. The chart below compares basic fundamentals for Southwest, United, and Delta. These three companies are similar in size. Southwest has a market cap of $9.52 billion, United has a market cap of $10.03 billion, and Delta has a market cap of $12.84 billion.

LUV

UAL

DAL

Trailing   P/E

23.36

N/A

12.76

Forward   P/E

10.72

6.09

4.98

Profit   Margin

2.46%

-1.95%

2.75%

ROE

6.07%

-63.23%

N/A

Operating   Cash Flow

 $2.06 Billion

 $935.00 Million

 $2.48 Billion

Dividend   Yield

0.30%

N/A

N/A

Short   Position

N/A

8.20%

1.80%

 

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Let’s take a look at some more important numbers prior to forming an opinion on this Southwest…

E = Equity to Debt Ratio Is Strong

The debt-to-equity ratio for Southwest is much stronger than the industry average of 2.00.

Debt-To-Equity

Cash

Long-Term Debt

LUV

0.45

$2.97 Billion

$3.15 Billion

UAL

27.37

$6.54 Billion

$13.17 Billion

DAL

N/A

$3.37 Billion

$13.24 Billion

 

T = Technicals Are Strong  

Southwest has outperformed United and Delta over the past year. What makes this especially impressive is that Southwest hasn’t used as much debt to fuel growth. It should also be noted that Southwest offers a small yield of 0.30 percent whereas United and Delta don’t offer any yield.

1 Month

Year-To-Date

1 Year

3 Year

LUV

6.28%

27.35%

65.41%

-1.28%

UAL

-4.85%

27.59%

44.95%

45.51%

DAL

-5.97%

28.64%

55.66%

4.73%

 

At $13.04, Southwest is trading above all its simple moving averages.

50-Day   SMA

12.12

100-Day   SMA

11.19

200-Day   SMA

10.12

 

E = Earnings Have Been Inconsistent             

Revenue has consistently improved on an annual basis. Earnings have been inconsistent, but they have remained on the correct side of the line.

2008

2009

2010

2011

2012

Revenue   ($)in   billions

11.02

10.35

12.10

15.66

17.09

Diluted   EPS ($)

0.24

0.13

0.61

0.23

0.56

 

When we look at the last quarter on a year-over-year basis, we see an increase in revenue, but a decline in earnings. However, on a sequential basis, revenue declined and earnings increased. Truth be told, quarterly earnings shouldn’t be overanalyzed. It’s always better to look at the annual progress for a clearer picture.

12/2011

3/2012

6/2012

9/2012

12/2012

Revenue   ($)in   billions

4.11

3.99

4.62

4.31

4.17

Diluted   EPS ($)

0.19

0.13

0.30

0.02

0.11

 

Now let’s take a look at the next page for the Trends and Conclusion. Is this stock an OUTPERFORM, a WAIT AND SEE, or a STAY AWAY?

T = Trends Might Support the Industry

If circumstances were to remain the same, then trends would support the industry, but as well all know, change is a guarantee. The status of the economy, increased competition, regulatory pressures, and fuel all have the potential to cause turbulence.

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Conclusion

Southwest is a very well-run company, but as noted earlier, there are several industry concerns. Contrary to popular belief, the price of oil is more likely to go down than up, which is a positive, but this would be due to decreased demand and a slowdown in the economy after the Federal Reserve begins to slow stimulus and interest rates increase. That said, the slowing of stimulus and an increase in interest rates are far from guarantees in today’s world. Therefore, there could be more room for the stock to run. However, capital preservation should always take priority over risk. Southwest isn’t the best option for investors focused on capital preservation.

Southwest is a WAIT AND SEE.

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