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If You Want to Own an Airline, Get on Board With Southwest

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  • LUV

Southwest Airlines (NYSE:LUV) has had a surprisingly weak year. LUV stock rallied from $45 to $65 this spring as traders loaded up on travel stocks.

a southwest airline stocks (LUV) jet flying above the clouds
a southwest airline stocks (LUV) jet flying above the clouds

Source: Carlos E. Santa Maria / Shutterstock.com

As the Delta variant set in, however, that enthusiasm faded. Southwest has given back nearly all its gains. LUV stock is now up just a couple of percent year-to-date. It isn’t just the pandemic causing problems, either. Southwest has had labor issues as pilot and personnel shortages have caused flight cancellations across the industry. Higher jet fuel prices don’t help matters, either.

Still, with shares closing in on their 52-week lows once again, it’s worth giving LUV stock another look. Admittedly, it’s not all blue skies for the airline. However, there’s more good than bad for the company as it flies into 2022.

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Earnings Are Improving

Last quarter, Southwest made a profit on a GAAP accounting basis, though it was marginally unprofitable once you exclude certain non-recurring items. Still, this was a big improvement from the pandemic, when all the airlines were burning tons of cash.

The improvement starts on the top line. Southwest’s revenues more than doubled year-over-year. Impressively, its Q3 revenues were only down 17% versus the same period in 2019. That’s well ahead of many airlines.

A big part of that is because Southwest is more oriented toward vacation and friends and family travel, which has come back much more quickly than business travel. Southwest also has a sizable route network in Latin America; Latin America has reopened to foreign travel much more quickly than Europe or Asia. Mexico in particular lifted most Covid-19 restrictions a year ago and thus has seen a tourist boom. Southwest has 15 different routes to Cancun alone.

Southwest’s load factor also came in at 80.7%. This means that more than four seats out of five were filled on the average Southwest flight last quarter. That’s close to pre-pandemic averages. All told, things are starting to look a lot closer to normal out there.

Analysts see the improvements continuing once Southwest makes it past the holidays. The consensus earnings estimate surges to $2.25 per share for LUV stock in 2022 and more than $4 per share in 2023. That would put shares at 21x and 11x those forward earnings, respectively.

Some Headwinds Persist

Now, it’s not all good news for Southwest. While much has gone right in terms of the economic reopening and travel recovery, a lot of headwinds remain.

The most visible is the price of jet fuel, which is largely determined by the price of crude oil. Oil had slumped sharply during the pandemic as demand dropped. That’s reversed sharply and oil now sits near its five-year highs. That will either cut airline profit margins or force them to raise ticket prices.

Labor issues are another concern. Last month, American (NYSE:AAL) and Southwest both canceled thousands of flights. Part of this was blamed on weather issues, but clearly there were some issues with the airlines being understaffed as well. Southwest’s payroll, for example, has shrunk from 60,000 people to 54,000 people since the pandemic started. That leaves it with less back-ups available for busy weekends or when many employees are unable to work.

It will be critical that Southwest can keep itself staffed up ahead of the busy Thanksgiving and Christmas traveling rush. To that end, Southwest is offering its employees extra reward points for work during the holiday season. That should help with on-time flights, but might hit margins.

Add it all up, and Goldman Sachs downgraded LUV stock to neutral on Tuesday. It cited higher costs and also some specific things to Southwest such as its investments in IT and new planes. These are obviously necessary moves long-term, but could serve as a drag on Southwest’s results as compared to other airlines in the short run.

LUV Stock Verdict

A key thing to realize here, however, is that many of those negatives for Southwest apply equally or more so to the other U.S. airlines as well. Southwest, with its strong balance sheet and skilled management team, is in a better position than rivals to ride out the current turbulence.

There’s a reasonable case for avoiding all airline stocks here. They have a much less clear path back to prosperity than certain other Covid-related sectors. However, if you want to own an airline today, LUV stock looks like the best choice out of the major carriers. Its low cost structure and reliance on leisure travel further boost its strong fundamentals in terms of the balance sheet.

It won’t necessarily be an overnight recovery. But LUV stock should work its way higher over the next 12 to 18 months. Especially if we get through winter without another big Covid-19 surge, Southwest shares could finally reclaim their pre-Covid levels.

On the date of publication, Ian Bezek did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.

Ian Bezek has written more than 1,000 articles for InvestorPlace.com and Seeking Alpha. He also worked as a Junior Analyst for Kerrisdale Capital, a $300 million New York City-based hedge fund. You can reach him on Twitter at @irbezek.

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