Description

Quick Take. Good way to invest in the emergence from Covid-19 crisis. Southwest Airlines was the best-run US airline company before the pandemic, weathered the pandemic crisis better than the others (see ASM numbers in chart below), and will come out the other end even more dominant within the US. Much of this excellent performance will continue due to a built-in strategic advantage that Southwest has carried for many years, as studied in numerous business school case studies and the like, more detail below. Near-term, LUV will benefit from built-it travel demand in 2H '21 and 2022, the beginning of this recovery can be seen in ASM performance in chart below. 

Average Seat Miles

Valuation. Estimated 2023 earnings are $4.63, once a full recovery has occurred (which by the way, could occur in 2022 at the current rate of US vaccinations). At these levels, LUV is trading at 13.7x ‘23 P/E, a 5x discount to the S&P ’23 P/E. This discount has persisted for some time despite 40+ years of consecutive positive earnings (except for 2020) and growing EPS by 500% since 2000. Historically LUV has increased earnings at 8% per annum on average, bought back 3-5% of its shares/yr, paid 1-2% cash dividend, and prospects look bright from here. Last time I checked, the S&P index could not offer that level of return. 

Assuming 5x discount to S&P multiple maintains, then LUV could trade at 17x 2023 P/E = $79/share (23% upside) with an upside branch to $101/share (58%) if LUV closes gap to S&P. Cash dividend = $0.72/yr is nice to have.

 US Airline Comps

Built-in Competitive Advantage.

• Point to point routes result in lower cost hub fees, more on-time reliability, leads to peer leading pre-Covid operating margins (15% vs ~10% for US peers) 
• All airplanes are the same Boeing 737 which means easier swapping can occur and more robust, lower cost, in-house maintenance and care, operates planes 9.4 hours per day vs peers at 8.6 hours 
• Friendly service, fare transparency, seating transparency, creates significant loyalty amongst customers 
• Will benefit from long-term secular decline in price of oil / savvy at locking in futures prices given reliability of traffic 

(See further detail on overview of the business by nassau799 in May 2019)

Covid Competitive Advantage, (and 737 Max Crisis too)

• Point to point leads to greater diversification against quarantine restrictions will contribute to built-in operating margin near term / can be aggressive in taking market share in existing markets 
• Will come back to full capacity quickly once vaccination roll-out completed in the US, opportunity to take market share in existing markets, due to customer loyalty (once you fly a few times with Southwest, the freebies become meaningful so you fly even more with Southwest) 
• Strong balance sheet / still took $2.4B in ‘free’ PPP money / declined CAREs loan 
• Can be aggressive in taking market share in new markets, and management gets that; added 17 new cities since pandemic began
  • Southwest unveils major summer expansion with a whopping 36 routes 
• Taking advantage of drop in cost of 737 Max 
• Younger fleet will lead to more energy efficiency and lower overall fuel costs. The current fleet is 11.4 years compares to 13.8 years for peer group and this spread will further increase.

Key Risks:

Another 737 Max Crash. Self-explanatory.

A deadly Covid variant not protected by the vaccine. Self-explanatory.

Catalyst

Robust US summer of travel post extensive US vaccination campaign

Cash dividend eligible to restart September 2021