In this article, let's take a look at Southwest Airlines Co. (LUV, Financial), a $21.73 billion market cap company, which is a major passenger airline that provides scheduled air transportation in the U.S. Some of the largest publically traded companies in the industry include Delta Air Lines (DAL, Financial), United Continental Holdings (UAL, Financial), US Airways Group (LCC, Financial), JetBlue Airways (JBLU, Financial), and SkyWest (SKYW, Financial).
Drivers and Expectations
Southwest Airlines is one of the largest domestic airlines in the U.S. and has focused on reducing costs by flying one aircraft type on direct point-to-point routes to secondary airports. As a result, the firm achieved the maximum profit from aircraft and employee productivity.
But what we expect in the near future? We believe the firm will benefit from better prices as passenger demand is increasing. The actual scenario of lower oil prices drop is a cost advantage for Southwest.
In July 2014, the firm started international flights and it plans to expand routes and frequency in the future. We believe this is a good way to continue growing.
Bullish Funds
Ken Griffin increased his position in the stock through Citadel Investment Group by 251% to $102.6 million with 2.32 million shares in the company's latest filing. Jim Simons (Trades, Portfolio) also increased the position by 26% to 111,277 shares, valued at $2.51 million. Lee Ainslie initiated a position with 5,910 shares, while RS Investment Management, Steven Cohen, Joel Greenblatt and Ray Dalio have taken long positions in the first quarter.
Bearish Funds
On the other hand, Paul Reeder and Edward Shapiro remain bearish on the company as evidenced by their decreased position in the company's shares by 51% to 2.65 million shares. A more bearish sentiment was demonstrated by Stanley Druckenmiller who sold out of the stock. PRIMECAP Management, John Keeley, Paul Tudor Jones, James Barrow and Pioneer Investments have taken short positions in the quarter.
Stock Price Performance
The stock has returned 4.7% in the first quarter, -23.2% on a year-to-date basis, and 19.8% over the past 52 weeks.
Although the company is being investigated by the Justice Department for possible price collusion, on July 1, analysts at Buckingham upgraded the company to "buy" but lowered its price target from $45 to $43. Considering a median of $44, there exists about a 35.4% of upside potential from the actual closing price. Moreover, according to Yahoo! (YHOO, Financial) Finance, the estimated one-year target share price is $47.46, reflecting a future price appreciation of 46%.
Revenues, Margins and Profitability
Looking at profitability,revenues increased by almost 6% and earnings per share tripled in the first quarter compared to the same quarter a year ago ($0.66 vs $0.22). During the past fiscal year, the airline increased its bottom line. It earned $1.65 versus $1.06 in the previous year. This year, Wall Street expects an improvement in earnings ($3.34 versus $1.65). Further, the airline has an impressive record of years of operating profits. Here we can see the evolution in the past quarters, which looks attractive.
| QuarterEnded | Dec12 | Mar-13 | Jun-13 | Sep-13 | Dec13 | Mar-14 | Jun-14 | Sep-14 | Dec14 | Mar-15 |
| OperatingMargin (%) | 2.18 | 1.71 | 9.33 | 8.58 | 8.69 | 5.16 | 15.47 | 12.79 | 13.40 | 17.67 |
Finally, let´s compare the best measure of performance for a firm's management: the return on equity. The ROE is useful for comparing the profitability of a company to that of other firms in the same industry.
| Ticker | Company | ROE (%) |
| LUV | Southwest Airlines | 26.5 |
| HA | Hawaiian Holdings Inc | 25.79 |
| LFL | LATAM Airlines Group SA | -5.08 |
| ALK | Alaska Air Group Inc | 30.51 |
| CPA | Copa Holdings SA | 15.98 |
| Â | Industry Median | 10.09 |
The company has a current ROE of 26.5% which is higher than the industry median. Also, it is higher than the one exhibit by LATAM (LFL, Financial) and Copa (CPA, Financial). In general, analysts consider ROE ratios in the 15-20% range as representing attractive levels for investment. So, for investors looking at those levels, Hawaiian Holdings (HA, Financial) and Alaska Air Group (ALK, Financial) could be appropriate options. It is very important to understand this metric before investing and it is important to look at the trend in ROE over time.
| QuarterEnded | Dec12 | Mar-13 | Jun-13 | Sep-13 | Dec13 | Mar-14 | Jun-14 | Sep-14 | Dec14 | Mar-15 |
| ROE (%) | 4.46 | 3.38 | 13.04 | 15.02 | 11.82 | 8.37 | 25.30 | 17.61 | 10.70 | 26.50 |
We must mention that current ROE exceeded the one from the same quarter one year prior, and this is a sign of strength.
Relative Valuation
In terms of valuation, the stock sells at a trailing P/E of 15.52x, trading at a discount compared to an average of 16.40x for the industry. To use another metric, its price-to-book ratio of 3.18x indicates a premium versus the industry average of 1.93x while the price-to-sales ratio of 1.19x is above the industry average of 0.54x.
The stock price has an upward trend in the five-year period. If you had invested $10,000 five years ago, today you could have $28,645, which represents a 23.4% compound annual growth rate (CAGR).
Final Comment
It seems that the antitrust investigation, which is a negative image in the airline industry, doesn't have too much impact. Meanwhile, the company signed a new multi-year partnership marketing deal with Avis Budget Group (CAR).
Further, good operating profits as well as the PE relative valuation and the return on equity that significantly exceeds the industry average make me feel bullish on this company, which also has an active share repurchase program.
Disclosure: Omar Venerio holds no position in any stocks mentioned.
