Southwest Airlines (LUV) should hit $10 by year-end. Here's why I'm so confident on this value airline (the fourth largest in the United States) that has blown away its peers again and again.
Opening in January of this year around $8.60 levels, LUV shares crossed the $10 level in early February after the announcement of a quarterly dividend before investors sold off shares through the end of May. In the last month or so, equity shares of the company have gradually picked up to trade at levels in the $9.20-$9.30 range over the last week. With its elegantly simple customer service ("We like to think of ourselves as a customer service company that happens to fly airlines") and rewards programs, famously friendly staff, and powerful brand name, I strongly believe Southwest Airlines is positioned to cross $10 before 2012 is out.
As of the end of operating year 2011, Southwest Airlines served 72 cities in 37 U.S. states. Subsidiary AirTran served 68 U.S. and international destinations. In sum, Southwest Airlines and subsidiaries operated nearly 700 Boeing (BA) aircraft. In comparison to traditional and value peers Delta Air Lines (DAL), American Airlines (AMR), JetBlue (JBLU), Spirit Airlines Inc. (SAVE), SkyWest (SKYW), Alaska Air (ALK), United Continental (UAL), US Airways Group (LCC), Latam Airlines Group (LFL), RyanAir Holdings PLC (RYAAY), Copa Holdings (CPA), TAM SA (TAM), Allegiant Travel Co (ALGT), Cathay Pacific (OTCPK:CPCAY), and others (OTCPK:ICAGY), Southwest has strong business metrics and a powerfully compelling market position for potential longs.
Market capitalization stands at over $7 billion, TTM EPS is at $0.37, P/B TTM is at 1.02, and the stock has suffered greatly in the last year. While the stock has suffered over the last few years with the greater airline industry trends, it may be time for LUV to buck the downtrend. Book value per share was $7.38 in 2009, $8.38 in 2010, $8.88 in 2011, and is projected to be above $9 in 2012, signaling strong support at recent levels around $9 at least. Moreover, return on equity remains strong above 4%. For me, the book value per share support is the most persuasive argument to go long; the potential returns if Southwest continues to capture more market share are too great to stay away from this investment. My internal analysis demonstrates a potential implied price per share of over $11.50 even with relatively conservative assumptions about cost of capital and growth multiples.
Dividend yield stands at 0.4%, beta is right with the greater market, and synergistic accretion from the AirTran acquisition is beginning to be seen in EPS. Southwest has very healthy cash on its balance sheet, with $2.6 billion in 2009, $3.5 billion in 2010, and $3.1 billion in 2011. Assets have grown substantially over this period, from $14.3 billion in 2008 to over $18 billion today.
Of course, nothing is guaranteed. If the global macroeconomy indeed does not pick up, the airline industry continues on its downward spiral, and Southwest does not see the revenue and expense synergies expected, LUV may continue to underperform. I consider this to be highly improbable. Still, skeptical or more cautious investors may consider an options play here. LUV 10.0 Calls with an expiration on Jan 19 2013 are currently going for $0.50 per contract, and I would strongly recommend purchasing some quantity of these at the very least. With six months to go in this medium-term derivative play, investors can have a strong margin of confidence that LUV shares may pick up the additional $.70 to put this call in-the-money as the global macroeconomy recovers slowly but surely.
As a Southwest customer, I'm happy to note the health of this company and wish it well in the future, not least because I am a long investor. I have no doubt that with such strong management and business metrics, LUV will exceed investors' expectations into 2014.
Disclosure: I am long LUV.
Additional disclosure: I may initiate a long position in BA over the next 72 hours.