Southwest’s Expanding International Service Will Lift Its Growth In The Coming Years

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Earlier this month, Southwest Airlines (NYSE:LUV) began flying to Mexico, taking over routes that were previously served by AirTran. [1] Prior to this, in July, the low-cost carrier begun flying to three near international destinations – Nassau, Aruba and Montego Bay. [2] Though these routes were already being served by AirTran, their take over by Southwest has brought the latter’s iconic Bags Fly Free service to these routes. Southwest fliers to these near international destinations can now carry up to two bags for free for the first time on international routes. In addition, a host of other Southwest policies like zero ticket change fee is now available to passengers flying to these destinations. Southwest has always considered that the additional passenger traffic that these policies bring more than compensates for the loss in revenue from baggage and ticket change fee. Thus, as lower fares, zero baggage and ticket change fee enabled Southwest to expand rapidly in the domestic US market, we figure these factors will enable the carrier to grow its share in these near international markets as well.

By the end of this year, Southwest plans to take over the remaining international routes currently served by AirTran. And, we figure over the long term, international expansion will likely play a key role in Southwest’s growth.

We currently have a stock price estimate of $29.35 for Southwest, around 5% below its current market price.

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Southwest Is Set To Increase Its Gains From The Latin Market

Growth in demand for flights in some international markets including Latin America is higher than the growth in demand for flights in the domestic U.S. market. With Southwest’s network restricted to the domestic market till a few months back, the carrier was not able to fully benefit from the fast growth in the Latin international market. Now, with the take over of AirTran’s existing international routes and further international expansion likely, we figure Southwest is well positioned to gain from the higher growth in Latin international markets.

The Carrier’s International Expansion Will Be Limited By Its Aircraft Type

The carrier’s international expansion over the long term however will be limited by its aircraft type. Southwest currently operates only narrow-body Boeing 737s that can fly up to the Caribbean, Central America and northern parts of South America. This strategy of operating a single aircraft type – the 737 – has been effected by Southwest to keep its operating costs low. Operation of a single aircraft type allows Southwest to lower its spare part inventory management costs, personnel training and other maintenance costs. Flying a single aircraft type also simplifies scheduling and flight operations.

Nonetheless, despite this range limitation, we figure expansion in near international markets will enable Southwest to lift its growth in the coming years.

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Notes:
  1. Southwest launches service to beach resort areas of Cancun and San Jose del Cabo, August 10 2014, www.swamedia.com []
  2. Southwest announces first international destinations, January 27 2014, www.swaamedia.com []