Southwest Is Flying at Cruising Speed

02/16/2010 12:30 pm EST

Focus: STOCKS

Jocelynn Drake

Financial Analyst, Schaeffer's Investment Research

Jocellyn Drake of Schaeffer’s Investment Research says the large discount airline had good earnings but little support on Wall Street, making it a good contrarian bet.

[A recent article in Fortune—“Southwest Stock Flies High,” February 2nd,] takes a closer look at Southwest Airlines (NYSE: LUV), which is beating the air-travel slump.

The biggest US discount airline surprised investors in January by posting earnings of $74 million, with lower jet fuel prices offsetting cheaper ticket prices. In addition, Southwest's stock has returned 50% in the past year, beating both the rise in the Standard & Poor’s 500 Index and global airlines' gain.

Analysts are mixed on the shares. Jim Corridore, equity analyst for S&P, contends: "Southwest can grow traffic when the rest of the US airline industry is hunkered down and trying to survive. Domestic and leisure travel—Southwest's sweet spot—will recover faster in 2010 than international and business travel."

Furthermore, [he continues,] "in 2009, Southwest moved unprofitable routes to better markets like Denver and Chicago, where they are now seeing strong demand."

However, Helane Becker, analyst for Jesup & Lamont, believes, "Southwest isn't adding new capacity this year, yet the stock is trading at almost 30x our 2010 earnings estimate—and that's assuming fairly aggressive profits, since our estimate is above other analysts'. We just feel airlines can sell at eight to ten times earnings."

To add to the company's headwinds, the firm is overhauling its computer system to handle international travel and, like other airlines, paying higher airport costs because travel is down.

Technically speaking, LUV has been in a strong up trend along its ten- and 20-week moving averages since early April 2009, and the equity has gained more than 1% since the beginning of 2010.

However, pessimism is on the rise toward the shares. The International Securities Exchange (ISE) has seen an increase in put trading. The ten-day put/call volume ratio rests at 0.93, which is higher than 78% of all those taken during the past year.

In addition, the ISE/Chicago Board Options Exchange (CBOE) ten-day put/call volume ratio comes in at 1.8, as put volume nearly doubles call volume. This ratio is higher than 98% of all those taken during the past year, pointing to a rising skepticism.

Wall Street also has its doubts, as 11 of the 16 analysts following the firm rate it a Hold or worse. Any upgrades from this group could send the bears scrambling for the bulls' camp, creating a wave of buying pressure.

(The stock closed just above $12 Friday, near its 52-week high—Editor.)

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