We are upgrading our recommendation on Southwest Airlines Co. (LUV) to Outperform based on falling fuel prices and strong growth opportunities. The company reported lower year-over-year earnings in the first quarter but outpaced the Zacks Consensus Estimate. Fuel prices, the major threat to the company's profitability, have dropped, which has made airline operations less expensive.
This lower cost, along with the cost-cutting measures, would offset high maintenance costs associated with the fleet modernization program amid the ongoing market turmoil. Additionally, Southwest is poised to benefit from fleet rightsizing, the Evolve retrofit program, steady capacity growth, All-New Rapid Rewards and several ancillary revenues.
The AirTran merger will also provide additional synergies when integrated with the company's livery, starting this year. Hence, we have an Outperform rating with a target price of $11, based on 13.75x our earnings estimate for 2012.
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