Southwest Airlines: Valuation In Question As Expenses Remain High

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Southwest Airlines Cancels Thousands Of Flights Across U.S.

Jim Vondruska

Southwest Airlines (NYSE:LUV) has had its adjacent stock of publicity complete nan past fewer years. Firstly, nan company's flagship Boeing (BA) 737 Max 8 were grounded owed to devastating crashes (in different airliners), which caused astir of nan company's fleet to beryllium retired of work for much than a twelvemonth and a half.

Secondly, and much recently, nan company's antiquated scheduling strategy caused wide cancellations complete this past vacation season, which garnered nationalist and world news and caused nan institution to salary retired immense sums of money to customers nether Department of Transportation regulations.

Beyond nan devastating damages done to nan stranded customers, nan institution faced terrible profitability hits arsenic they needed to salary retired damages to customers and salary for their fleet to beryllium idly by until nan 737 Max 8 fixes were successful place.

Now, while revenues are increasing astatine a faster complaint than their competitors, nett income maturation is projected to stay lukewarm comparative to those aforesaid competitors, causing value to net multiples to beryllium higher than those of different airlines. The mobility remains whether nan institution tin summation those margins to warrant this higher valuation aliases will they extremity up being overvalued and request to travel down some.

Let's dive in.

Sales Growth: Quite Better Than Peers

While astir airlines are engaged moving much and much 'amenities' into nan pay-to-get category, Southwest Airlines has been reliably accordant pinch their policies astir having a individual item, a transportation connected and 2 checked bags for free. They supply in-flight snacks, free texting and constricted Wi-Fi services for each flights and they do truthful astatine virtually nan aforesaid prices of different awesome airliners.

Companies for illustration United Airlines (UAL) and American Airlines (AAL) introduced different versions of nan basal system version, which gets you a spot connected nan craft and a individual point and astir different amenities are purchasable upon booking. Things for illustration spot selection, carryon bags, and checked bags are extra.

Given that nan prices are mostly nan aforesaid arsenic different awesome airlines (not debased costs airlines), they've received a batch of intrigue from caller customers. That and description crossed nan United States and various world markets successful North and South America allowed them to turn income astatine a faster complaint than peers.

Here's nan gross maturation complaint projections for nan adjacent 3 years:

2023 2024 2025
Southwest +14.2% +6.63% +6.95%
United +17.0% +5.48% +5.87%
American +8.06% +3.75% +4.15%
JetBlue +10.0% +6.96% +7.14%
Delta +9.69% +1.87% +3.28%

(Source: Seeking Alpha Earnings Projections - LUV - UAL - AAL - JBLU - DAL)

As we tin see, extracurricular of United Airlines this twelvemonth and JetBlue successful nan next, Southwest is projected to outpace competitors erstwhile it comes to gross maturation complete nan adjacent 3 years. But there's thing other - Southwest Airlines is predominantly a home hose while these different airlines run a bully spot successful world markets wherever maturation is higher.

Take United Airlines arsenic an example, their home operations revenues (the United States) roseate by astir 70% from 2021 to 2022, their past reporting afloat year, according to their 10-K filing. Their wide revenues, however, roseate by complete 82%, owed to nan higher maturation rates successful nan Atlantic, Pacific and Latin American markets.

GrandViewResearch Aviation Growth Rates

Aviation Industry Growth Rates (GrandViewResearch)

This intends that if we relationship for this maturation differential, Southwest would further outperform peers successful nan home (overall) gross markets. (Author excluded Latin American market, fixed that Southwest Airlines has immoderate world marketplace location arsenic well).

Net Income Growth: Not All That Great

When it comes to nett income, however, Southwest Airlines has immoderate improvements to make arsenic they're much aliases little in-line pinch astir different airliners, contempt nan truth that they are increasing revenues astatine a faster clip.

Here's really their nett income figures are projected to fare against awesome competitors complete nan adjacent 3 years:

2023 2024 2025
Southwest +138% +42.2% +23.7%
United +227% +19.4% +21.6%
American +302% +47.6% +54.9%
JetBlue N/A +159% +57.4%
Delta +62.1% +32.3% +17.2%

(Note: JetBlue reported a 2022 loss, owing to nan N/A year-over-year change)

The main logic why this maturation being in-line pinch nan manufacture at-large is that Southwest's value to net aggregate (P/E ratio) is rather higher than peers which tin beryllium a valuation concern.

Let's return a speedy look astatine P/E ratios for nan twelvemonth mentioned above.

2023 2024 2025
Southwest 12.3x 8.64x 6.98x
United 6.37x 5.34x 4.39x
American 8.03x 5.44x 3.51x
JetBlue 19.1x 7.37x 4.68x
Delta 7.41x 5.60x 4.78x

Multiples Suggest Company Is Overvalued

Given that nan institution isn't projected to amended nett income immoderate much than immoderate different airliner, it's difficult to spot why their precocious multiples are justified. The only measurement this is imaginable is nan imaginable of their nett income maturation pacing pinch their gross projections, comparative to its competitors.

Meaning, if nan institution is group to turn its income astatine a faster clip than competitors and they tin yet make it to a constituent wherever they would person akin margins arsenic those competitors, it's apt they'll besides outperform those companies erstwhile it comes to net per stock - frankincense justifying a higher P/E.

The reply to this mobility lies successful really 1 mightiness position their operating environment, driven by nan classical 3 factors affecting profitability.

Gross Margins Should Improve

Southwest has not yet gotten its gross margins up to a akin spot arsenic earlier nan pandemic and it's had a difficult clip doing truthful fixed nan aforementioned antagonistic factors. Currently, the company's gross profit margin is astir 25%, while successful 2019 it was conscionable complete 31%, nan afloat twelvemonth earlier nan world pandemic.

Ticket pricing is nan largest contributor present and it's unclear if formation prices are going to support heading up aft this agelong stint of ostentation we've been seeing. Business aerial recreation has besides been sluggish to return to normal and Southwest has been very unfastened astir pushing income respective times a year, which tin propose that nan mean value per paying rider will beryllium little successful bid to pull customers.

Operating Expenses Can Remain High

Operational costs were besides deed by nan precocious ostentation and costs increases will besides person immoderate longer word effects connected operating expenses. In nan shorter run, however, I expect nan institution will incur higher expenses connected behalf of strategy upgrades, formation unit increases and various payments to customers which are still being processed for stranded travelers.

Revenues roseate by 50.8% successful 2022 compared to 2021 and operating expenses roseate by 46.4% complete nan aforesaid clip period. It is noteworthy, however, that successful nan past twelvemonth nan institution reported astir nan aforesaid ballpark successful revenues, operating expenses were astir 20% lower, owing to things for illustration costs inflation, wide inflation, higher attraction costs and different factors.

Conclusion: Not So Sure About This One

Whether aliases not airlines tin retrieve afloat aft nan devastating world pandemic is simply a large mobility connected investors' minds. But Southwest Airlines has different problem, beyond their stranded passengers and antagonistic news coverage: I judge they are overvalued.

When we comparison nan institution to peers, while they are projected to turn revenues astatine a somewhat faster clip than its peers, costs of revenues and operating expenses, immoderate short word and immoderate longer term, stay higher than peers - causing little nett income growth.

These higher expenses, I believe, will persist longer than nan marketplace presently expects and frankincense warrant that nan company's stock value presently trades astatine astir nan aforesaid aggregate arsenic its peers.

This intends that I judge nan institution is reasonably weighted astatine astir 7.5x their 2024 projected net per share. At a projected EPS of $3.93, that would task adjacent worth of astir $29.50 per share, little than they are presently trading astatine by astir 15% arsenic of their latest trading price.

As a consequence of these factors, I americium somewhat bearish connected Southwest's value action, moreover arsenic their underlying business exemplary whitethorn let them to turn income astatine a faster clip than competitors. If investors are looking for vulnerability to hose stocks, I don't judge Southwest Airlines is nan 1 to spell astatine existent times.

This article was written by

Pinxter Analytics floor plan picture

As portion of my net maturation strategy, I invest, waste and acquisition and constitute astir mini under-covered maturation companies which don't get overmuch attraction from constitution analysts arsenic good arsenic usage nan strategy to construe short and agelong word moves successful bigger, good established companies successful nan United States, Europe and nan Asia-Pacific region.-All articles and nan accusation successful them are my sentiment based connected my ain investigation and study and should not beryllium taken arsenic finance proposal without due owed diligence and proposal from a master financial adviser.

Disclosure: I/we person a beneficial agelong position successful nan shares of BA either done banal ownership, options, aliases different derivatives. I wrote this article myself, and it expresses my ain opinions. I americium not receiving compensation for it (other than from Seeking Alpha). I person nary business narration pinch immoderate institution whose banal is mentioned successful this article.

Additional disclosure: Opinion, not finance advice.

Editor: Naga

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