I will be flying Southwest Airlines (LUV, Financial) this week to visit family. And, one thing that I noticed was that travelers have to use Southwest.com or the company's mobile app to book air travel. That is a competitive advantage and is likely to be one of the reasons Warren Buffett (Trades, Portfolio) likes the stock. His firm, Berkshire Hathaway (BRK.A)(BRK.B) owns over 56 million shares of Southwest, a $2.8 billion position.
Of course, Buffett is staying extremely close to the 10% ownership rule for each of his airline holdings, which also include Delta (DAL, Financial), American (AAL, Financial) and United Continental (UAL, Financial). Founded in 1967, Southwest is considered a regional airline, but the company has grown into the largest domestic carrier in the U.S. based on boarded passengers. It has roughly 700 Boeing aircrafts and does still specialize in short-haul flights, serving 100 cities across 40 states, and D.C., as well as close international destinations like the Caribbean and Mexico.
More Importantly, the company is rock-solid financially. Over the last decade, investors have seen Southwest's revenue, earnings and book value rise considerably. All while keeping debt and capital spending very low. In the last 12 months, it has produced $3.7 billion in net profit ($6.26 earnings per share) on $21.5 billion in revenue, growing book value to $18.06 per share. Southwest has $3.8 billion in cash and $3.5 billion in debt, far less than the majors. It also offers better deals on airfare with zero fees on baggage, free WiFi and no flight change fees. If you're not flying Southwest, you should.
Since September the stock has pulled back about 20% on warnings of higher fuel costs ($2.25 to $2.30 per gallon range) with existing hedges replaced by more expensive ones. The hedging program is one way Southwest has smoothed out the price fluctuation that plagued airlines in the past. Management expects non-fuel unit costs to rise about 3% in 2019. However, the company continues to expect capacity growth short term with 2019 earnings north of $5.00 per share. That number should continue to rise as the company is very aggressive with stock buybacks, making $6 billion worth since 2015. In fact, share count has been reduced by 107 million (15.6%) in the past three years alone.
The company's current valuation is completely off. If it earns $5 per share, with the industry average price-earnings ratio of 11.4, the stock prices at $57 a share. If that multiple rises to Southwest's five-year average (19.1x), the stock prices in at $95 a share. Maybe the tax breaks won't last and costs will rise faster than growth, but remember this.
Southwest has been consistently profitable for more than 40 years thanks to exceptional execution of its low-cost-carrier strategy. That's its brand power and unlike most major carriers that rely on third-party distributors for ticket sales, Southwest has succeeded using its own distribution channel, which accounts for roughly 85% of bookings, including mine this week. If any airline has an economic moat, it's Southwest.
Disclosure: I am not long/short any stock mentioned.
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