Five Reasons to Buy Southwest Airlines

12/06/2017 5:00 am EST

Focus: TRANSPORTATION

Richard Moroney

Editor, Dow Theory Forecasts

For years, Southwest Airlines (LUV) delivered sales and profit growth while other airlines stagnated, observes Richard Moroney, editor Dow Theory Forecasts.

Those obvious advantages no longer exist. Over the last five years, airlines benefited from a combination of unusually low fuel prices, artificially low interest rates, and strengthening demand for air travel. With plenty of airlines boasting solid growth histories, more companies have become relevant to investors.

Of course, airlines have lost some altitude lately. The industry index has fallen 9% since the end of June, as higher costs eroded analyst profit targets. Against this backdrop, it’s easy to come up with reasons to avoid Southwest. But we continue to rate it a Buy and a Long-Term Buy. Here are five good reasons why.

Growth:  Southwest still leads the formation. Over the last five years, Southwest managed annualized profit growth of 34%, tops among the airlines already profitable at the start of that period.

And over the last 12 months, a period when the industry saw profits decline an average of more than 28%, Southwest limited its decline to 4%, among the best in the group.

Fundamentals:  Our quantitative scores for the airline sector have been hurt by slowing growth, falling analyst profit targets, and weak share-price action. Southwest has held up better than the rest, earning an overall score of 85, tops in the industry.

Expectations:  Analyst profit projections for airlines have been falling almost across the board. However, in a recurring theme, Southwest hasn’t seen the type of declines its competitors have.

Over the last 90 days, the profit consensus has fallen 6% for the current year and 5% for next year, versus respective industry average declines of 9% and 11%. Analysts target a 5% profit dip for Southwest this year (versus an industry average of a 10% decline) and 25% growth in 2018 (more than triple the industry average).

Operating efficiency:  Southwest’s revenue per average seat mile (RASM) in the September quarter fell 1.4% from a year ago and would have been flat without the effect of hurricanes Harvey and Irma.

However, the company sees a rebound in Houston and Florida bookings, and the ongoing retirement of older planes continues to ease cost pressure. The upshot? Company projections of flat to 1.5% higher RASM in the December quarter and RASM growth in 2018.

Valuation:  At 17 times trailing earnings, the airline trades at a 41% premium to its industry. However, the premium is roughly in line with the average over the last decade, suggesting the shares aren’t especially pricey compared to its peers. Southwest’s P/E ratio is in line with its own five-year average.

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