At the beginning of this week, I used news about widespread flight cancellations as a launching pad to start looking at the airline industry. Airline stocks haven’t seen quite as much volatility as I thought they might from the news, which I’ll go ahead and take as an overestimation on my part about how much credence the market would really give that news. It’s also fair to say that in a highly cyclical industry, airline companies are well aware of the risks that come from inclement weather, and while not all contingencies can be anticipated, they do try to factor that risk into their operational models.
The fact that the Transportation sector, as measured by the iShares Transportation Average ETF (IYT), has risen by about 6% in just about three weeks since the turn of the new year looks like it could be a positive, although since the beginning of the week the sector has traced back by a little over 2%. Right now that looks like it could just be a simple pullback within the longer context of the sector’s latest rally, which means that there could be more bullish momentum in store for the sector in the near future. That makes this a sector worth paying attention to, with a number of carriers on both the national and regional level that I think deserve a place on any investor’s watch list.
Southwest Airlines (LUV) has enjoyed a reputation as something of a maverick in the industry for more than two decades, and even now is still garnering plenty of headlines from respected publications like FORTUNE magazine as one of the world’s most respected companies. That’s pretty rarified air for a company that started as a regional carrier but over the years has expanded its footprint throughout the United States and parts of Central America and the Caribbean. Their ability to differentiate themselves from their competition has helped them thrive and even to disrupt the way the industry operates. From a fundamental standpoint, they stand on firmer ground that either Delta Air Lines (DAL) or American Airlines Group (AAL), and boast a value proposition right now that I think should put them at the top of the list of transportation stocks you should be paying attention to right now.
Fundamental and Value Profile
Southwest Airlines Co. (Southwest) operates Southwest Airlines, a passenger airline that provides scheduled air transportation in the United States and near-international markets. The Company provides point-to-point service. The Company offers ancillary service offerings, such as Southwest’s EarlyBird Check-In and transportation of pets and unaccompanied minors, in accordance with Southwest’s respective policies. Southwest’s Rapid Rewards frequent flyer program enables program members (Members) to earn points for every dollar spent on Southwest fares. Its Internet Website, Southwest.com, is an avenue for Southwest customers to purchase and manage travel online. As of December 31, 2016, Southwest operated a total of 723 Boeing 737 aircraft and served 101 destinations in 40 states, the District of Columbia, the Commonwealth of Puerto Rico, and eight near-international countries: Mexico, Jamaica, The Bahamas, Aruba, Dominican Republic, Costa Rica, Belize, and Cuba. LUV’s current market cap is $28.7 billion.
- Earnings and Sales Growth: Over the last twelve months, earnings increased by almost 23%, while revenues rose a little less than 6%. In the last quarter, earnings declined -14%, while sales were also negative by -2.91%. The company operates with a very healthy margin profile, with Net Income running at 17.1% of Revenues for the last twelve months, but narrowing in the last quarter to just a bit over 11%.
- Free Cash Flow: LUV’s free cash flow is healthy, at $2.5 billion. That translates to a Free Cash Flow Yield of 9%.
- Debt to Equity: LUV’s debt/equity ratio is .47, implying management has been very effective at managing their debt levels. More to the point, in the last quarter cash and liquid assets were a little over $3.8 billion, while long-term debt was around $4.7 billion. When you combine these numbers with the company’s healthy operating profits, you have a company that can service its debt very comfortably while still maintaining excellent liquidity and financial flexibility.
- Dividend: LUV pays an annual dividend of $.64 per share, which translates to a dividend yield of about 1.25% at the stock’s current price.
- Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value. LUV’s Book Value is $18.06, which means that the stock’s Price/Book ratio right now is 2.82. Their historical average Price/Book ratio is 3.72, which means that on the most useful valuation metric that I like to use, the stock offers a long-term target price above $67 per share, which is about 32% higher than its current price.
Here’s a look at the stock’s latest technical chart.
- Current Price Action/Trends and Pivots: LUV’s 52-week high came in late September at around $64 per share. The stock decline from that point to its December low at around $44 marked an intermediate-term decline of about 31%. Since that point, the stock has rallied a little more than 15% higher. Its most recent pivot high a little below $52 appears to be a pretty strong resistance level, which means that if the bullish momentum the stock has built over the last few weeks has any chance of being sustained, the stock has to break that level first. If the stock keeps retracing from that pivot high, the most likely near-term support point is probably around $47 per share. A break below the stock’s 52-week low at $44 would mark a confirmation of the stock’s intermediate downward trend, and should give the stock bearish momentum to move into a long-term downward trend, with the next bottom probably in the $37 price area. Based on price action in that range not see since late 2016.
- Near-term Keys: The stock could offer an excellent short-term bullish trading opportunity, using the stock itself of call options, with a break above its current resistance around $52. If that happens, look for a near-term target price to close the trade at around $55 per share. I don’t think trying to play the stock’s roughly $4 difference between the current price and where I think its nearest support lies is a very high probability trade, so shorting the stock or buying put options really wouldn’t make sense unless the stock sets a new 52-week low by breaking below $44 per share. I think that the fundamentals for the company are strong enough, and the bargain argument for the stock is compelling enough right now, to consider using this stock to take a conservative, long-term bullish position in the stock.