It's OK To Trim Some Southwest Airlines Right Now

About: Southwest Airlines Co. (LUV)
by: Abba's Aces

Southwest Airlines has been a great investment for me this year, and specifically during the third quarter.

Earlier in November, just before the presidential election the pilots union approved their looming labor deal.

The massive run up in airline stocks during the third quarter did not prevent the likes of Warren Buffett from jumping into the industry.

Southwest Airlines (NYSE:LUV) has been a great investment for me this year, and specifically during the third quarter. I LUVed it so much that I owned it in my Portfolio of 12 that I write about regularly and in my IRA. However, I closed the position in my Portfolio of 12 back in November and the majority of the stake in my IRA. In the Portfolio of 12 I closed out the position for a 29.5% gain (or 185% annualized) and in the IRA the position I closed was for a gain of 4.2% (or 15.8% annualized) with the remaining shares up 27.5%. Because I still own the stock for my IRA I believe that I must continue to keep tabs on the company so I know what to do with the shares I have remaining.

Earlier in November, just before the presidential election the pilots union approved their looming labor deal. 84% of the voting members gave their nod of approval which will see pay increase 15% and 3% annually thereafter for the next four years. Because of these terms Southwest expects labor costs to rise by 3.5% during the fourth quarter. The deal was anticipated by investors and analysts alike so the stock did not move much on the news. I believe this is a great move to lock up the pilots for the next four years because Southwest has one of the happier employee base among the airlines and when you have happy employees you tend to have a great customer base in a service oriented industry.

Despite having great employees the airline is still susceptible to computer malfunctions which cause massive delays. Earlier this year the company experienced a computer glitch that cause a massive outage for its flight and in November another glitch took place at airline-tech firm Sabre that affected Southwest passengers from creating bookings, ticket changes, and the use of the mobile boarding pass. Though it wasn't as massive as the glitch earlier in the year it still shows that the airline industry needs to make massive investments in their technology infrastructure to mitigate the risk of losing future business.

The massive run up in airline stocks during the third quarter, however, did not prevent the likes of Warren Buffett from jumping into the industry after years of snubbing it. Berkshire (NYSE:BRK.A) (NYSE:BRK.B) took initial stakes in American (NASDAQ:AAL), Delta (NYSE:DAL), and United (NASDAQ:UAL) according to the 13F filing but then CNBC uncovered that the conglomerate also took a piece of Southwest (Southwest rose 2.8% on the back of the news). I don't know that it was a great move by The Oracle of Omaha at this particular moment because costs from labor to fuel are increasing in the industry. But perhaps demand for travel will heat up as the economy begins to improve again to be able to offset some of those costs.

The vote of confidence from Berkshire though proves that the airline industry has gotten their homes in order in their operational activities. They have been practicing fiscal discipline, operational efficiency, and creating an experience for the reluctant traveler. Everyone knows that Mr. Buffett is one of the more patient investors so he is not in these names just for the short-term. He obviously sees some value in them for the long-term so investors may see some short-term ups and downs, but eventually if Mr. Buffett is correct as he always is, these names should be a good investment.

However, all airlines are not created equal either. United recently announced an effort that its low-fare customers will only be allowed to bring one carry-on bag on their flights. Creating this restriction will pretty much be a scheme to try and get their customers to pony-up for the higher fare seats quicker so that United can manage their revenues better in the future. My thought on how Southwest will counter this action is by doing a promotion against the other airlines and the baggage policy, trying to bring some of those customers over to Southwest. We'll just have to wait and see, I love those Southwest commercials though!

Southwest is one of the better performing airline stocks this year as it is up 11.3% but it is driven strictly on the almighty metric of passenger revenue per available seat mile [PRASM]. If the gross domestic product number begins to move faster investors can see these PRASM numbers increase quickly. The industry is still very fragmented because there are a lot of competitors which is good for the consumer at the present time. But it would not be surprising to see some more consolidation in the space after the most recent mergers are digested which is not so good for the consumer in the future as fare prices will more than likely go higher.

From a valuation perspective, they are all relatively inexpensive when compared to the market, but Southwest seems to be the most expensive one in the group to me. Trading at around 13x next year's earnings estimates with little to now earnings growth for next year just does not make it a worthwhile investment for me right now, but I cannot argue with the value investor himself, Mr. Buffett. Oil prices have started to climb which should eat into profits and that is partly the reason why I wanted to be out of the name.

At the end of the day it only matters what a stock has done for your portfolio and for me Southwest was a great investment. I will continue to hold the little shares that I do in my IRA until I see a serious reduction in earnings estimates, otherwise I'm going to let it fly and hopefully my IRA follows along with it. For now here is a glance at my IRA and how each position has performed. Thank you for reading and I look forward to your comments.



% Change incl. DIV

% of Portfolio





The Boeing Company




Southwest Airlines Co.



Robert Half International Inc.




Johnson & Johnson




LyondellBasell Industries N.V.




AT&T Inc




Intel Corporation




Helmerich & Payne Inc




Ameriprise Financial




Affiliated Managers Group Inc.




Cummins Inc




Hasbro Inc




Skyworks Solutions Inc.




Invesco Ltd.




Apple Inc.




The Home Depot, Inc.




Caterpillar Inc




Wyndham Worldwide Corporation




Delphi Automotive PLC




H&R Block, Inc.




AbbVie Inc.




PPG Industries, Inc.




Amgen Inc.







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 and happy investing!

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.