Southwest Stock Is The Safest Airline Bet – Take It

by Trefis Team
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Southwest Airlines
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Southwest Airlines (NYSE: LUV) has fortified its balance sheet with multiple transactions including notes offering, equity raise, and sale-leaseback arrangements. Per recent filings, the company has $13 billion of cash and short-term investments which can support it through the coronavirus crisis for a good 20 months. While the company has added nearly $9 billion of debt on the balance sheet over recent months, Trefis believes that the stock is undervalued considering Southwest’s high operating margin, strong domestic presence, and low-ticket pricing. As the lockdown restrictions are lifted and new Covid-19 cases decline, the domestic air traffic demand is expected to grow sooner than later. Notably, passenger numbers at TSA checkpoints have surged by 50% since June 1. Our dashboard, Southwest Airlines Valuation: Expensive Or Cheap? provides detailed forecasts of revenues, margins, and valuation multiple. We believe that the company’s stock is worth $44 – a figure roughly 30% ahead of the current market price.

Despite expanding long-term debt, high profitability will support earnings

In 2019, Southwest Airlines generated $22.4 billion of total revenues and incurred $19.4 billion in operating expenses – achieving an operating margin of 13%. The company also incurred $657 million of income tax, which brought the net income margin to 10%. Moreover, the company’s $118 million of interest expenses were offset by interest income on short-term investments.

As Southwest Airlines revealed in its Q1 SEC filing that its daily cash burn rate is around $30 million, Trefis expects the company to have added nearly $2.7 billion to its debt pile by the end of Q2 2020. Assuming that air travel demand recovers completely by the first quarter of 2021, the additional interest expense of $100 million will bring down the net margins by just 0.5%. Also, the company’s high operating profit margin can support the daily cash burn of $30 million for the full year with the $9 billion in recently-raised debt being utilized to cover fixed costs. That said, a scenario in which demand for air travel remains depressed for the rest of the year is bound to have a structural impact on the overall airline industry. Given those circumstances, we believe the company will very likely be able to reduce its cash burn rate further by re-negotiating with contractors, employees, and associated stakeholders.

If air travel demand doesn’t recover until September, Southwest is the safest bet

In 2019, Southwest Airlines carried 158 million domestic passengers, around 20% of the total domestic traffic, making it the largest domestic carrier by passenger enplanements. Moreover, the airline has the most competitive ticket pricing amongst major carriers at $0.158 per revenue passenger mile. In 2019, Delta Airlines and United Airlines reported passenger yield of $0.178 and $0.166, respectively.

As the international travel demand is likely to remain low from the stringent self-quarantine measures implemented by various countries, we expect the airline industry’s cash flows to be supported by domestic operations in the near-term. Also, the $13 billion of liquidity and a huge domestic presence makes it the safest bet among all airline stocks. We estimate Southwest Airlines’ valuation at $44 per share utilizing a P/S multiple of 2.5, $8.8 billion in annual revenues, and 515 million shares outstanding.

 

While Southwest looks like a good bet in the near- to mid-term, 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.

See all Trefis Price Estimates and Download Trefis Data here

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