The stock market’s recent swoon has created a buying opportunity in certain sectors of the economy; travel and leisure stocks look especially oversold, asserts Jim Pearce, editor of Investing Daily's Personal Finance.
Now that most travel and leisure businesses can be bought at discounted prices, I am adding an airline stock to our portfolio to participate in what I believe will be a strong rebound in business and personal travel in 2022 and beyond.
Over the first four months of this year, Southwest Airlines (LUV) rose 35% as COVID-19 vaccines allowed the public to travel safely on airlines. Over the next four months, LUV fell 20% as a troubling rise in the Delta variant of the virus pushed travel and leisure stocks lower.
However, the expected decline in airline passenger traffic was short-lived and may already be over. In percentage terms, passenger airline traffic is now roughly 75% of what it was before the coronavirus pandemic sent the travel industry into a tailspin.
That means airline traffic must increase by a third just to get back to where it was two years ago. When that happens, ticket sales for Southwest should grow by at least that amount.
There is a lot of market share up for grabs. The pandemic forced most airlines to cut back on routes and lay off staff. Some of them added a lot of debt to their balance sheets to remain solvent, limiting their ability to use that capital for growth initiatives when airline travel is fully restored. Southwest has made clear its intent to gain market share in the months to come.
When it released its Q2 operating results in August, the company’s CEO, Gary Kelly, stated: “While the rapid ramp up in June travel demand provided stability to our financial position, it has impacted our operations following a prolonged period of depressed demand due to the pandemic. Therefore, we are intensely focused on improving our operations as we restore our network to meet demand.”
He did not wait long to act on those words. On September 13, the company announced the sudden retirement of its president, who will be replaced by the company’s COO. In February, Kelly will step down as CEO to complete an overhaul of the company’s most senior officers.
To be sure, the new management team has its work cut out for it. During the second quarter, Southwest recorded a 32.2% decline in operating revenues compared to the same period in 2019. However, that apparently poor result is slightly better than the 33.7% drop in passenger traffic during the same span.
According to Kelly, the company’s “balance sheet strength remains unmatched in the U.S. airline industry and a competitive differentiator.” He also believes, “2022 will be another transition year in the pandemic recovery, and our primary goals will be to deliver operational reliability with optimized resources; generate solid profits and margins; restore and grow the route network and reduce carbon emissions intensity.”
At first glance, Southwest appears expensive — valued at more than 100 times trailing 12-month earnings. However, its 12-month forward price/earnings ratio (FPER) of 17 is well below the FPER of 22 for the S&P 500 Index.
I expect operating results for the airline to improve markedly over the next six quarters. I am adding Southwest Airlines to our model Growth Portfolio with an initial buy limit of $55.