Southwest Airlines Took Off, Were You In The Stock?

| About: Southwest Airlines (LUV)

Summary

I have been bullish on the airline for the past two months at least as I have owned it in my regular trading account and my IRA.

For the month of September the company reported that revenue passenger miles increased by 7.9% as capacity was up 6% from last year.

Bernstein initiated coverage on Southwest with an “Outperform” rating and a price target of $51.

The last time I wrote an article on Southwest Airlines (NYSE:LUV) was earlier this month and I titled the piece, "Showing Southwest Airlines Some Love." I'm glad I did, as the stock is up 8.5% since that time. I have been bullish on the airline for the past two months at least as I have owned it in my regular trading account and my IRA. So with this run up in the stock price I would like to do a check up on the health of the company to see if there is some more room to move higher.

Since that time oil has climbed from $46 to $51 and one would imagine that it would be a headwind for the company but the increase in consumer confidence numbers appear to be a stronger tailwind than the increase in oil prices. Just using some anecdotal experience, I have been traveling across the country for the past four months and I can't claim that I have seen many empty chairs which leads me to believe that the airlines have discovered the resolution to their capacity issues.

Southwest in particular had reached an agreement with their pilots union, however it was thought to be threatened after the Delta union deal was agreed upon. The Delta situation was going to pay their pilots more than Southwest's pilots and the Southwest deal took about four years to negotiate. A better deal would have eaten away at margins for quite some time but thankfully shareholders can rest easy as no new deal is being sought after the Delta agreement. Under the terms of the current agreement the pilots will receive an increase of 29.4% compounded over the four-year deal.

For the month of September the company reported that revenue passenger miles increased by 7.9% as capacity was up 6% from last year. With this report the company reaffirmed its third quarter guidance it gave previously with operating revenue per available seat mile falling into the 3.5% to 4.5% range due in part to the operations glitch that occurred back in July. Investors cheered these results because it wasn't any worse news than what was expected, and in fact proved to be great news for the airline.

Part of the increase in revenue per passenger miles was the fact that fares increased by 0.4% during the month of September which stopped the downtrend which was recently started. But alas one data point does not make a trend and fares are expected to continue to move down till Thanksgiving. Revenues in the airline industry tend to be seasonal so it is no surprise that fare prices should continue to move down during the months of October and November. I have certainly noticed the drop in prices as I was able to purchase a cross-country flight for $178 recently.

After these results were issued, Bernstein initiated coverage on Southwest with an "Outperform" rating and a price target of $51. After this initiation by Bernstein it brought the total number of analysts giving the stock a price target to thirteen with an average price target of $49, or a 15.5% increase from today's closing price of $42.43. Southwest is set to report earnings before the market opens on Oct. 26 with analysts calling for an average of $0.88 per share on the bottom line on average revenue of $5.2B.

From a fundamental analysis perspective the company currently trades at a trailing 12-month P/E ratio of 11.23, which is inexpensively priced, but I mainly like to purchase a stock based on where the company is going in the future as opposed to what it has done in the past. On that note, the 1-year forward-looking P/E ratio of 11.04 is currently inexpensively priced for the future in terms of the right here, right now. Next year's estimated earnings are $3.85 per share and I'd consider the stock inexpensive until about $58. The 1-year PEG ratio (5.5), which measures the ratio of the price you're currently paying for the trailing 12-month earnings on the stock while dividing it by the earnings growth of the company for a specified amount of time (I like looking at a 1-year horizon), tells me that the company is expensively priced based on a 1-year EPS growth rate of 2.04%. In addition, the company has great long-term future earnings growth potential with a projected EPS growth rate of 13.19%.

I actually initiated my position in Southwest in late August and have been pretty happy with the purchase thus far. So far, I'm up 144.8% on an annualized basis, but will not purchase shares until they get below $36, because I believe that is where Southwest offers additional value. I've selected $36 because it is the average price at which I currently own my shares. But I think if anyone can get it below $42 it also offers value there as that is the midway point of the 52-week range.

A great way to enter the stock would be to write the December $38 strike put for $0.50 and use those proceeds to purchase the December $47 strike call for $0.45. If the stock doesn't get that low by December, then at least an investor collected the premium and perhaps maybe even made a profit on the call which was purchased.

I swapped out of Allergan (NYSE: AGN) for Southwest Airlines during the 2016 third quarter portfolio change-out because I owned Allergan for the speculation that the Pfizer deal was going to go through, and I ended up turning a profit in the name (2.8%, or 6.6% annualized) and wanted to lock in those profits. Since the swap, I have made out on some gains, as Southwest has outperformed the market and Allergan since the swap. For now, here is a chart to compare how Southwest and Allergan have done against each other and the S&P 500 since I swapped the names.

Click to enlarge

When it is all said and done, it matters what the stock has done in an investor's portfolio at the end of the day. For me, Southwest is my third-largest position and has been doing well, as I'm up 15.9% on the name, while the position occupies roughly 12.1% of my portfolio. I continue to believe in the name because it has a lot of momentum going its way. I own the stock for the value portion of my portfolio, and I will continue to hold onto the stock for now. My portfolio is up 6.9% since the inception of my portfolio, while the S&P 500 is up 3%. Below is a quick glance of my portfolio and how each position is performing.

Company

Ticker

% change incl. DIV

% of Portfolio

The Priceline Group Inc.

(NASDAQ:PCLN)

28.41%

6.19%

Southwest Airlines Co.

15.85%

12.12%

Electronic Arts Inc.

(NASDAQ:EA)

10.66%

4.02%

KLA-Tencor Corporation

(NASDAQ:KLAC)

5.02%

5.43%

Target Corp.

(NYSE:TGT)

0.08%

8.18%

AbbVie Inc.

(NYSE:ABBV)

-1.23%

3.17%

T. Row Price Group, Inc.

(NASDAQ:TROW)

-3.51%

11.31%

Diageo plc

(NYSE:DEO)

-6.47%

4.47%

Silver Wheaton Corp.

(NYSE:SLW)

-10.40%

3.97%

Signet Jewelers Limited

(NYSE:SIG)

-10.41%

11.84%

Gilead Sciences Inc.

(NASDAQ:GILD)

-12.33%

16.31%

SIG OCT 21 2016 85.00 CALL (Open)

-96.56%

0.04%

DEO OCT 21 2016 120.00 CALL (Open)

-97.21%

0.01%

Cash

$

12.92%

Click to enlarge

Disclaimer: This article is in no way a recommendation to buy or sell any stock mentioned. This article is meant to serve as a journal for myself as to the rationale of why I bought/sold this stock when I look back on it in the future. These are only my personal opinions and you should do your own homework. Only you are responsible for what you trade.

Disclosure: I am/we are long LUV.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.