What’s Next For Southwest Stock After A 20% Rise This Year?

Southwest Airlines (NYSE: LUV) reported its Q4 results earlier this year, with revenues and earnings above the street estimates. The company reported operating revenue of $6.8 billion, and adjusted earnings of $0.37 per share, compared to the consensus estimates of $6.7 billion and $0.11, respectively. LUV stock has surged over 20% this year, but we think it’s overvalued now. In this note, we discuss Southwest’s stock performance, some key takeaways from its recent results, and its valuation.

LUV stock has faced a notable decline of 20% from levels of $45 in early January 2021 to around $35 now, vs. an increase of about 35% for the S&P 500 over this roughly three-year period. Notably, LUV stock has underperformed the broader market in each of the last 3 years. Returns for the stock were -8% in 2021, -21% in 2022, and -14% in 2023. In comparison, returns for the S&P 500 have been 27% in 2021, -19% in 2022, and 24% in 2023 – indicating that LUV underperformed the S&P in 2021, 2022,  and 2023.

In fact, consistently beating the S&P 500 – in good times and bad – has been difficult over recent years for individual stocks; for heavyweights in the Industrials sector including GE, CAT, and UNP, and even for the megacap stars GOOG, TSLA, and MSFT.
In contrast, the Trefis High Quality (HQ) Portfolio, with a collection of 30 stocks, has outperformed the S&P 500 each year over the same period. Why is that? As a group, HQ Portfolio stocks provided better returns with less risk versus the benchmark index; less of a roller-coaster ride as evident in HQ Portfolio performance metrics.

Given the current uncertain macroeconomic environment with high oil prices and elevated interest rates, could LUV face a similar situation as it did in 2021, 2022, and 2023 and underperform the S&P over the next 12 months – or will it see a recovery? From a valuation perspective, LUV stock looks overvalued. We estimate Southwest Airlines’ Valuation to be $31 per share, compared to its current market price of around $34. Our forecast is based on 0.7x sales for Southwest, aligning with the stock’s average over the last two years.

Southwest Airlines’ revenue of $6.8 billion in Q4 reflected a 10.5% y-o-y rise, driven by a solid 21.4% rise in available seat miles (ASMs), partly offset by a 7.6% fall in passenger revenue per available seat mile. The company’s adjusted operating margin stood at 2.7% in Q4’23 versus -5.6% in the prior-year quarter. This resulted in earnings rising to $0.37 per share, compared to a loss per share of $0.38 in Q4’22. Looking forward, Southwest expects its capacity to expand 6% in 2024 and fuel costs per gallon to be between $2.55 and $2.65. Thus compares with the $2.95 figure in 2023.

While the overall travel demand remains robust, elevated costs and a likely decline in passenger yields could weigh on Southwest’s near-term performance. The stock has already seen a sharp move lately, and we think investors willing to enter will likely be better off waiting for a dip.

[1] Returns as of 3/7/2024
[2] Cumulative total returns since the end of 2016

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