Southwest Airlines: Rewards Outweigh The Risks

| About: Southwest Airlines (LUV)

Southwest Airlines (NYSE:LUV) has come a long way since its founding in 1971 with only three 737 jets then running out of three cities in Texas. It now operates a fleet of over 700 Boeing aircraft and serves 73 cities in 38 states as the largest airline in terms of domestic originating passengers in the United States. Its short route and low-fare services have made it a leader in the domestic airline industry and give it a unique identity in the highly competitive airline market. In an industry marked by companies filing for bankruptcy and others being assimilated by larger airlines, Southwest has proven to be resilient, logging net profit in each of its last three years.

Customer service and low fares are at the center of Southwest's strategy and it maintains a consistent record of offering the lowest fares and the least hassles. It prides itself on innovative policies that differentiate it from other airlines such as its "Bags Fly Free" marketing slogan that takes advantage of other airlines' policies in order to show value in Southwest Airlines. While it has recently gained access to destinations in Mexico and the Caribbean, Southwest Airlines does not currently have any intercontinental routes, keeping its focus on the United States' airline market.

In May of 2011, Southwest Airlines announced the acquisition of AirTran Holdings Inc, which is the owner of AirTran Airways. The acquisition opened up key destinations in the Caribbean and Mexico and will ultimately allow Southwest Airlines to serve over 100 million customers each year through over 100 airports across the country. During the acquisition, Southwest Airlines also promised to expand its presence at key airports such as New York LaGuardia, Boston Logan, Milwaukee, and Baltimore/Washington, while adding services to smaller domestic cities that it currently does not fly to.

The addition of AirTran Airways to the Southwest family has allowed it to compete stronger domestically against JetBlue Airways (NASDAQ:JBLU) and United (NYSE:UAL), and has contributed to its revenue growth of just shy of 32% over the last twelve months. Comparatively, JetBlue and United have only seen growth of 22% and 5.5%, respectively, giving Southwest Airlines the edge in domestic growth. Southwest Airlines is unable to compete with United internationally, however, giving United Airlines a market to compete in without Southwest Airlines' interference.

Despite unpredictable fuel costs over the last three years, Southwest Airlines has proved its profitability even as other airlines have slipped into the red on rising energy costs. In 2009, it reported net revenue of $99 million followed by a great year in 2010 with revenue of $459 million. Last year, as oil and gas prices began to climb significantly, Southwest Airlines was still able to secure a net profit of $122 million, which speaks volumes of its resilience in an industry that is so greatly affected by the cost of fuel.

Over the last year, Southwest Airlines' stock took a bit of a dive, dropping from $12 per share to $8 for a loss of 25% of its value over twelve months. It has risen over the last three years, however, from $6 per share back in 2009. I believe that its ability to remain profitable, even as other airline companies slide into the red each time energy prices take off, gives Southwest Airlines an advantage over the competition and makes it a sleeper with the potential to lift off when it exceeds its expectations and outperforms its competition.

Southwest Airlines' six-month moving average is currently $8.88 and it has been flirting with that average since the beginning of 2012. In my opinion, a position here is relatively cheap, and while it carries a small measure of risk, it could pay off greatly if Southwest is able to break its six-month moving average, sending it into a bullish run for the rest of the year.

I wouldn't put all of my apples in this basket and I would attempt to find something more reliable to invest in as a hedge, but I believe that the potential gain here is well worth the risk. Southwest Airlines' consistent ability to remain profitable is bound to attract investors and its expansion into new markets as the result of its acquisition of AirTran Airways will offer rewards that are yet to be discovered.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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