Southwest Airlines (NYSE:LUV) this week traded broadly in line with market’s mood throughout the week. In the November operational results released earlier this week, Southwest saw a 2.5% y-o-y rise in passenger traffic during the month of November. This was aided by improved occupancy rates and marginally higher capacity. November traffic gains barely aided recovery and the industry earnings forecast downgrade by International Air Transport Association (IATA) further weighed on the sentiment of airline stocks during the week.
However, some positive news came as Southwest received route authority approval from the U.S. Department of Transportation (DOT) for AirTran to operate international flights to new destinations in Mexico beginning May 2012. By far the biggest Latin American market from the US is Mexico. The collapse of Mexicana last year, then the largest Mexican carrier in the US with about 18% of the US-Mexico market, led to a widening in the gap between US and Mexican airlines. (See Latin America’s international market: still dominated by foreign carriers, Airline Leader). Low-cost peer Alaska Air Group (NYSE:ALK) has also expanded presence in Mexico lately, to fill the void created in these markets.
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IATA expects North American carriers to continue to gain from limited capacity
IATA has downgraded its forecast for airline profits from $4.9 billion to $3.5 billion for a net margin of 0.6% for 2012, while the Euro zone crisis puts severe downside risk on the 2012 outlook. IATA highlighted that North American carriers were able to improve yields and occupancy rates this year on the back of capacity cuts and thus outperformed the industry body’s profit forecasts. Deriving further benefits from conservative capacity management, IATA expects North American carriers to generate profits of $1.7 billion in 2012, maintaining the strongest EBIT margin of 2.4%
American Airlines bankruptcy poses challenge to the industry
IATA has warned that the competition in the region will only intensify further as American Airlines evolves with a more competitive cost structure as a result of the bankruptcy filing. American is expected to use bankruptcy to renegotiate with its workforce, mainly pilots, to optimize costs as well as pension liabilities. This poses further challenge to low-cost carriers like Southwest, whose cost advantage over legacy competitors is gradually deteriorating as heavy fuel bills and labor costs warrant regular fare hikes.
We have Trefis price estimate of $10.60 for Southwest, implying a premium of ~28% over the current market price.