How Do Crude Oil Prices Impact Southwest’s Enterprise Value?

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Jet fuel cost, one of the major operating costs for an airline, accounts for close to 30% of the total operating costs of any airline. Jet fuels are typically made by blending and refining various crude oil petroleum distillation products. Hence, a small change in crude oil prices can have a significant impact on these costs, and, in turn, on the profitability, as well as cash flows, of an airline.

Comparison of Crude Oil Prices & Jet Fuel Prices

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In this note, we discuss, how crude oil prices impact Southwest‘s fuel costs, and, in turn, its enterprise value. As discussed previously, a decline in crude oil prices can result in a notable drop in jet fuel costs, causing the profits to improve. For this reason, Southwest, the Dallas-based low-cost carrier, has been posting huge profits over the past few quarters on the back of sliding crude oil prices. In the table below, one can see how Southwest’s fuel costs as a percentage of revenue have dropped sharply over the last year, largely due to the weakness in the oil prices globally.

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Since fuel cost is such a critical factor for an airline, we discuss below how the movement in crude oil prices can impact the enterprise value of Southwest. In our base case, we assume that the demand-supply mismatch in the oil markets will ease out over the long term, resulting in a gradual improvement in the oil prices. Accordingly, we expect crude oil prices to recover to $100 per barrel by 2021. In this case, the airline’s enterprise value will stand at $33.4 billion. However, if we assume that the over-supply in the oil markets prevail for longer-than-expected, and oil prices reach only $90 per barrel by 2021, Southwest’s enterprise value will be $38 billion, or 14% higher than our base case. Similarly, in a downside case, where oil prices reach $110 per barrel in 2021 due to higher demand, the airline’s enterprise value will fall to $24.3 billion, more than 27% lower than our base case. Thus, we figure that crude oil prices have a notable impact on Southwest’s enterprise value.

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Have more questions about Southwest Airlines (NYSE:LUV)? See the links below:

Notes:

1) The purpose of these analyses is to help readers focus on a few important things. We hope such lean communication sparks thinking, and encourages readers to comment and ask questions on the comment section, or email content@trefis.com

2) Figures mentioned are approximate values to help our readers remember the key concepts more intuitively. For precise figures, please refer to our complete analysis for Southwest Airlines

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