Southwest Airlines: Lots To 'LUV'

| About: Southwest Airlines (LUV)
This article is now exclusive for PRO subscribers.


Consistent profitabily.

Falling fuel prices.


I flew down to Florida a few weeks ago. While there, I gained an intimate knowledge of the Sunshine State's extensive flora and fauna. It's too bad I was on a golf trip. Anyway, on the return flight, one of my golfing buddies asked me if I had any stock ideas I'd like to share. I don't believe I've ever met a stock I didn't like, so I spent the next 20 minutes pelting my friend with ideas both great and small. It was about that time that I noticed his eyes had glazed over and there was a small rivulet of drool trickling from the corner of his mouth. Ever alert to the subtle signs of one losing an audience, I suggested that a very good investment might be under our very noses, or better put, under our derrières. My friend came to life, thanked me for my input and started flirting with the woman sitting beside him. The investment I allude to of course, is Southwest Airlines (NYSE:LUV), and if you've a moment, I'll try not to bore you as I did my friend.

I remember Peter Lynch of Fidelity Magellan Fund fame saying that stock research can be done in a place as mundane as a shopping mall. If a potential investor knew which stores were publicly traded, that investor would be well served to see which was the busiest. Simplistic? Not really, just a good first step into making an investment decision. So, taking this advice to heart, I took note of the fact that both my Southwest flights were full. When any company, and especially an airline, has the track record of Southwest, perhaps the first step is the only step one needs to take. Read on to see what I mean.

In an industry as competitive as airlines, the fact that LUV has bested its competitors in profitability over the past decade is no small feat. In fact, Southwest has been profitable for 43 consecutive years, with the latest year setting a record of $2.4 billion in net income. Perhaps a better illustration of just how well run this airline is would be the fact that during the dark years of 2001 through 2005, while the rest of the industry was losing close to $60 billion, Southwest made $2.1 billion.

I'm sure you've noticed that filling the gas tank on your car isn't quite as grim a task as it used to be. A few extra bucks in the pocket is nice. LUV is benefiting too, and in a big way. In the fourth quarter alone, Southwest reduced fuel costs by $189 million. For all of 2015, Southwest's fuel costs were $1.3 billion lower that of the previous year. The first quarter of 2016 has LUV hedged at around $1.70 a gallon of motion lotion. A caveat is in order here. In 2008, LUV locked in some unfavorable prices near oil's high. (Sounds like my timing.) In 2009, LUV had net income of $99 million, its worst year in a decade. This was a direct result of these ill-timed hedges. It took the airline until 2013 to shrug off the bad bets. I guess even the experts get it wrong sometimes. Anyway, on to more positive things.

Southwest has returned nearly $1.5 billion to shareholders in 2015 through share buybacks and dividends. Admittedly, the dividend yield is rather anemic, but the dividend itself has been gaining momentum over the last 3 years. Also, with a payout ratio of just 9%, there's plenty of room for expansion in the future. $10,000 invested 5 years ago in Southwest has grown to $30,000 today. That's a return of nearly 25% a year.

Here are a few more numbers that might be of interest to you. In fiscal 2015, LUV earned $3.52 a share. Estimates for 2016 range from $4.28 to $4.65 a share. At the present price of $36 and change, LUV is trading at around 11 times earnings. Let's be optimistic and assume Southwest earns $4.50 a share this year. Given the same P/E ratio, you looking at a $50 stock. A 38% increase in share price. Not bad. In addition, analysts expect LUV to grow 22% annually over the next 5 years. I'm rather dubious about that prediction. Five years is a stretch. But a $50 or $55 stock for 2016 looks more than possible.

I noticed you stifled a yawn. I'll finish up with a few more points and leave you alone.

Southwest and its workers, 80% of which are union, enjoy good relations. In fact, the company returned $620 million in profit sharing to its labor last year. Happy campers.

Southwest has the healthiest balance sheet in the industry.

Southwest concentrates on the short-haul market, thus lowering food costs, shrinking turnaround times and reducing ground service.

Southwest flies only one type of plane, which simplifies everything from scheduling to training.

Southwest books 95% of its customers electronically, 80% of which are handled through its own website.

These are just a few of the practices LUV employs to give it one of the lowest cost structures in the airline industry.

There's a lot things to like about LUV. I've just touched on a few. If you do your homework, I'm sure you'll find many more. Let me know what you think.


Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in LUV over the next 72 hours.

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.