After rewarding shareholders with healthy returns in 2016, Southwest Airlines Co. (LUV, Financial) is off to a great start heading into 2017. The stock was up nearly 30%, representing a new all-time high, at the beginning of July. Although the stock has tumbled approximately 15% since then, it is still up 10% year to date.
Southwest’s recent downturn started after reporting underwhelming guidance on revenue per available seat mile for the second quarter.
U.S. carriers continue to be the most profitable airlines around the globe, with all major carriers producing a significant economic profit (EP) in 2016 and over the past five years. Not only are the four largest U.S. airlines, which include American Airlines (AAL, Financial), Delta Airlines (DAL, Financial), United Continental Holdings (UAL, Financial) and Southwest Airlines, the top EP earners, but they are also the four largest market cap airlines worldwide.
Source: consultancy.uk
Southwest Airlines reported strong second-quarter results last month. For the quarter, the airline logged earnings per share of $1.24, beating estimates by four cents. On the other hand, revenue came in at $5.74 billion, again surpassing the consensus by $20 million. Most significantly, that figure represents a surge of almost 7% year over year.
Moreover, the airlines’ revenue per available seat mile (RASM) increased 1.5%. Although this was considerably lower compared to the unit revenue growth delivered by other airlines, it it still impressive. The low-cost carrier’s unit revenue growth helped it compensate for most of the cost pressure it has been facing recently.
While Southwest's margins plunged modestly on an annual basis, it still managed to deliver a marvelous 21% adjusted operating margin in the prior quarter. Moving ahead, the airline anticipates RASM growth of nearly 1% year over year for the next quarter.
Southwest is aslo well positioned to deliver superior margin expansion as well as hasty earnings growth next year as it starts to benefit from its enduring fleet transition, new IT system and improved hedging results.
Southwest is also aggressively focusing on returning cash to shareholders via dividends and share repurchase programs. The airline has escalated its spending in this area from $950 million in 2014 to nearly $1.5 billion in the prior quarter.
Summing up
While Southwest Airlines has managed to remain in the green over the past several years, the recent plunge in its stock price has left shareholders debating whether the lower price should be considered a good buying opportunity or a warning sign to avoid the stock.
Southwest continues growing at a healthy rate and is focused on its next phase of growth. In 2014, the airline added several international routes for the first time. Since then, the company has continued to add new international routes every year and plans to add three new routes this fall.
The company offers a dividend yield of 0.91%, which is not striking. However, shareholders should keep in mind its payout ratio currently sits at just 13.1%, suggesting it has plenty of room to grow its dividend in the future.
Another factor that might worry shareholders is Southwest’s price-earnings (P/E) ratio of 16.6 is considerably greater than the industry’s average. Regardless, the low-cost carrier boasts striking profitability metrics which are more than enough to justify a higher P/E ratio.
As a result, investors should consider adding Southwest Airlines to their portfolio as its recent pullback presents a great buying opportunity.
Disclosure: No position in the stocks mentioned in this article.
