Pick Southwest Stock Over American Airlines For Better Gains?

LUV: Southwest Airlines logo
Southwest Airlines

The shares of American Airlines (NASDAQ: AAL) have declined by 38% in the past year compared to a 19% drop observed in Southwest Airlines (NYSE: LUV) stock. Does that make American a better pick over Southwest? Given the ongoing vaccination efforts in multiple countries and the possibility of economic recovery by mid-2021, Trefis believes that Southwest stock can provide better gains to investors willing to bet on the slow-moving airline industry. Per PSP2 (second phase payroll support program) restrictions, airline companies cannot return capital to investors through dividends and share repurchases until March 2022. Despite a substantially higher current P/S multiple, Southwest stock has room for more growth as the $1.7 billion of PSP2 proceeds can completely offset the company’s Q1 losses at a cash burn rate of $17 million per day. Importantly, American Airlines’ $25 billion of net debt makes the stock subject to additional headwinds in the current low demand environment. We compare the historical trends in revenues, margins, and valuation multiple of both companies in an interactive dashboard analysis, American Airlines vs. Southwest Airlines – parts of which are highlighted below.

1. Revenue Growth

Southwest’s growth has been almost similar to American Airlines over the last three years, with LUV’s revenue expanding at an average rate of 3.5% per year from $20.3 billion in 2016 to $22.4 billion in 2019, versus AAL’s revenue which grew by 4.5% from $40.2 billion in 2016 to $45.8 billion in 2019.

  • In 2020, American Airlines observed 50% (y-o-y) capacity contraction with a 64% load factor. Whereas, Southwest reported 34% (y-o-y) capacity reduction with a 52% load factor – lowering the gap between AAL and LUV’s top line.
  • In 2020, American Airlines and Southwest Airlines reported $17 billion and $9 billion of total revenues, respectively.
Relevant Articles
  1. Can Southwest Airlines Stock Lead A Bull Market Rally?
  2. Will Southwest Airlines Stock Gain Momentum In The Near-Term?
  3. Why Southwest Airlines Stock Remains A Favorable Bet
  4. Southwest Airlines Stock, Time To Buy?
  5. Southwest Airlines Stock Poised For Strong Gains?
  6. Is There A Better Pick Over Southwest Airlines Stock Ahead Of Earnings?

2. Returns (Profits)

Southwest’s operating profit margin has consistently been 6-percentage points higher than American – mostly due to a lower share of salary expenses as a percentage of revenues.

  • In 2020, American Airlines reported $17.4 billion of revenues and $8.8 billion of net loss – at a net margin of -50.5%
  • Southwest’s net margins were much better at -24% due to significantly lower interest, salary, and depreciation costs.
  • Thus, Southwest observed just $1 billion of operating cash outflow compared to the larger $6.5 billion by American.

3. Risk

Per Q4 2020 filings, American and Southwest reported $32 billion and $10 billion of long-term debt on their balance sheet, respectively. After getting restructured in 2012, American Airlines’ debt-laden balance sheet has not been able to shed weight mainly due to high competitive rivalry, which limited airfares and lowered margins.

  • Currently, American Airlines has $6.8 billion of cash & short-term investments against total debt of $32 billion. With just $10 billion of market capitalization and a huge $25 billion of net debt, Trefis believes that AAL stock faces headwinds in the near-term. More importantly, dividends and share repurchases are suspended until March 2022 – limiting economic returns for short-term investors.
  • Southwest reported $13 billion of cash & short-term investments against total debt of $10 billion. Interestingly, LUV’s $26 billion market capitalization is more than twice of AAL with a significantly lower net debt.
  • Higher financial leverage coupled with continued revenue growth is a boon for generating surplus equity returns. However, slow growth and loaded balance sheets negatively affect shareholder returns during recessionary periods. Thus, American Airlines’ stock has lower upside potential compared to Southwest in the near future.

What if you’re looking for a more balanced portfolio instead? Here’s a high-quality portfolio to beat the market, with over 100% return since 2016, versus 55% for the S&P 500. Comprised of companies with strong revenue growth, healthy profits, lots of cash, and low risk, it has outperformed the broader market year after year, consistently.

See all Trefis Price Estimates and Download Trefis Data here

What’s behind Trefis? See How It’s Powering New Collaboration and What-Ifs For CFOs and Finance Teams | Product, R&D, and Marketing Teams