3 Reasons Why Southwest Airlines Still Has Room To Grow
From: Seeking Alpha - Jan. 10, 2015 6:11 AM ET
"Southwest Airlines was one of the top performing stocks of 2014.
With strong financials and a favorable economic climate, the company should be able to continue growing in 2015.
A capable and shareholder-friendly management team makes this company a good long-term buy and hold.
Introduction
Southwest Airlines (NYSE:LUV) was one of the top performers of the S&P in 2014, posting a gain of 121%. With a tremendous run like that, many investors may feel that it is too late to buy the stock at its current levels. However, I believe that LUV is still a great company for long-term investors to buy and hold well into the future. Although the stock is unlikely to match its 2014 gains in 2015, I believe that it will outperform the S&P 500 (NYSEARCA:SPY) both in 2015 and over the long term. LUV has many favorable headwinds going forward that will make this happen. First, the decrease in fuel prices will help LUV continue to deliver growth; both in 2015 and in the future. Second, the management team is committed to increasing shareholder value and has a plan to steadily increase growth into the future. Finally, the company boasts strong and favorable financials. As a note to readers, unless otherwise cited in the article, all information contained is being pulled from the Q3 press report, which can be accessed here.
A Favorable Economic Climate
It is no secret that the cost of oil is experiencing a rapid decline. Since jet fuel is a major expense throughout the industry, this decline in oil will help all airline companies improve operating margins and increase profits. Investors also need to remember that the drop in oil will help generate more revenue due to an increase in consumers electing to fly. Cheaper oil means cheaper flights, as well as more money in the pocket of consumers who drive gas vehicles on a regular basis. This has already become apparent in the November release of monthly flight data, which showed significant year over year improvements in load factor, revenue per passenger, revenue passenger miles, and enplaned passengers. Look for this improvement trend to continue with the December data release, which should be coming out soon. (Note: See here to access the definition of above terms as well as other airline industry terms.)
It should also be noted that LUV relies on futures contracts to purchase a significant percentage of its jet fuel. Management forecasted that about 20% of LUV's fuel for Q4 would come from such contracts, and the company owns a significant amount of these derivatives going out into 2018. Looking forward to the Q4 and annual earnings, I would like to see how much jet fuel the company has locked in at current prices for future years. I expect that management is guaranteeing itself significantly cheap oil well into the future, and this will help protect operating margins and sustain profits if the current oil decline is only a temporary situation.
Shareholder Friendly and Growth Driven
As apparent by its ticker, LUV puts its investors first. Through the first 9 months of 2014, the company repurchased $755 million. LUV still has $580 million remaining under its existing $1 billion share repurchase authorization. These share repurchases will help increase shareholder value even if the growth rate slows. Management has also reached an impressive return on invested capital of nearly 20% over the last 12 months, and if that continues then expect more share repurchases and dividend increases. Finally, LUV has maintained a dividend for 153 straight quarters. Although the yield is relatively miniscule, the commitment to the dividend and the low payout ratio gives investors an important margin of safety when purchasing LUV. Investors aren't the only ones who feel the LUV with this company though. Management has created a great business culture, and Glassdoor recently ranked Southwest #6 in the top companies for culture and value for 2014. Southwest is also famous as a consumer friendly company - cheap flights, bags fly free, and flight attendants that rap the pre-flight safety brief all create a fun and easy flying experience.
As an older, more mature company, LUV is unlikely to display explosive growth numbers in the future. However, it seems poised to maintain a steady pace of growth that will keep the stock moving upwards. Management has taken on a few initiatives to spur future growth. First, the company is in the midst of its Fleet Modernization. The CEO, Mr. Gary Kelly, gives an update on this process in his 2013 annual report to investors. Fleet Modernization will continue into the end of this decade, and will give LUV planes that are more fuel efficient with more seating. The end state will be an increase in profits from lower operating costs and more revenue passengers carried.
Fleet Modernization will also allow Southwest to expand its current service routes, and service more high demand locations with nonstop flights. This is a specific stated goal in the 2013 annual report, and we are already beginning to see this come to light. Seven new nonstop domestic flights have been announced and will start in June 2015. In the future, Hawaii and Alaska are expected to become offerings for Southwest customers. More interestingly, the Fleet Modernization will allow LUV to start expanding its international offerings, and we are seeing this begin as well. Starting in October, you will be able to fly Southwest to three destinations in Mexico, as well as to Costa Rica and Belize. By 2019, Mr. Kelly would like to have expanded into more markets throughout Latin America and the Caribbean, and even into South America. These popular tourist destinations will provide growth for years to come.
The Financial Situation
The balance sheet at LUV looks very strong right now, and the company is well positioned to maintain its financial strength. As anyone who has followed the company knows, improvements to the operating margins have allowed the company to post an 80% gain in earnings per share year over year through the first 9 months of 2014. The recent quarter was a record in terms of profit. Modest revenue growth has also helped the company post these record profits. With the continuing decreases in jet fuel, there is a good chance that operating margins will continue to improve in 2015, and revenue should continue to show solid growth well into the future with management's plan to increase flight offerings and improve the fleet. Outside of the income statement, the balance sheet and cash flow at LUV look strong. According to Yahoo! Finance, LUV has $3.56 Billion in cash on hand, or approximately $5.25 per share. This cash per share increases the margin of safety for investors. Operating cash flow sits at $2.99 Billion for the trailing twelve months, and is steadily on the rise. The total debt on hand of approximately $2.77 Billion is a manageable number given the financial strength of the balance sheet and cash flow. Finally, investors should also note that 2013 was the 41st year in a row of profitability for the company; and barring a major unforeseen catastrophe for LUV 2014, will be year number 42. This is a phenomenal streak that should strike confidence in long-term investors."
AI
