Down 35% This Year, Is It Time For Recovery In Southwest Airlines’ Stock?

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Southwest Airlines

The Covid-19 pandemic has hit the travel industry hard. All major airlines reported have losses in Q1 2020 after operating profitably for years. The second quarter is going to be worse as the demand has dropped by nearly 90%! How is Southwest Airlines’ (NYSE:LUV) faring amid all this compared to peers?

Our assessment is – ‘better’. So is it a good time to invest? That depends on how the demand recovers and how well prepared is Southwest Airlines from a liquidity perspective to stay afloat and maintain capacity until the demand bounces. If it can do so, it may have a chance to take market share from other airlines when the situation improves. Below, we consider two demand recovery scenarios and assess Southwest’s cash flow in each. We find that in a pessimistic case, Southwest could post losses of > $2 billion, resulting in nearly $700+ million cash outflow, even after cutting its capital expenditure by 70%. Our dashboard Does Southwest Airlines Have Enough Liquidity To Survive Covid-19 Demand Shock examines the company’s cash flow generation ability and financing requirements in two different demand recovery scenarios. 

Scenario A: Travel Demand Bounces Back By Q4

  • Consider a case where the demand slump created by the pandemic fades by Q4 2020 and Southwest starts operating most of its domestic routes.
  • We assume a 30% revenue drop for the full year and some fiscal discipline from Southwest leading to a 50% reduction on capital expenditure and focus on maintenance of essential assets.
  • In addition, we assume share repurchases to be zero.
  • This results in an annual accounting loss of nearly $350 million, with Southwest still being able to generate a free cash flow of $800+ million.
  • This is surprising considering that for other airlines, even this scenario results in significant cash burn.
  • But what happens when we look at a grimmer scenario?
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Scenario B: Only Partial Demand Recovery By Q4 As Customers And Businesses Stay Put

  • In this scenario, we assume a 50% drop in annual revenue and fiscal discipline dictating a 70% cut in capital expenditure.
  • This results in an annual loss of > $2 billion on a revenue base of $11 billion, resulting in a cash outflow of over $700 million despite employing a huge cut in capex.
  • While slightly worrying, this is actually good news considering that its peer airlines are likely to face significantly higher burn.

In addition, Southwest Airlines has a healthy balance sheet. It has raised nearly $5.2 billion in debt financing this year, and its cash balance stood at nearly $3.9 billion at the end of Mar 2020.

Not all airlines are going to be this efficient. See how this airline can burn well over $4 billion in a case of attenuated demand recovery.

The airline stocks are in for a turbulent ride in the next few months. But which S&P 500 component stocks have the best chance of outperforming the benchmark index? Our 5 In the S&P 500 That’ll Beat The Index: TWTR, ISRG, NFLX, NOW, V look promising.

 

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