Southwest Airlines: Cleared For Takeoff
Mar. 29, 2018 11:26 AM•LUV
Summary
Southwests new revenue management tool relieves competition pressure, and may drive top line growth in 2018.
Consumers stand to spend more on travel this year, with Southwest reaping the benefits.
Shift into more fuel efficient aircraft within fleet stand to increase margins in the future.
Multiple expansion expected as performance metrics improve.
Southwest Airlines (LUV) stock has fallen over 7% the last several days, as management lowered their unit revenue guidance for the quarter. The company expects Q1 RASM to come in flat y/y (down from the 1-2% previously expected).
As management puts their new revenue management tool to work, Southwests top line should see positive results. Additionally, the shift into a more fuel efficient fleet stands to improve margins into the future. On a macroeconomic scale, we foreshadow an increase in travel demand in 2018 with Southwest positioned better than many of the competing airlines. Southwest remains a top pick in the industry, poised for continued success.
Financial Overview
Southwest reported revenue of just over $21 billion in 2017, up ~3.7% y/y. Since 2013, revenue has grown at a ~4.6% CAGR.
Southwest's top line remains safe in our eyes, as they put their revenue management tool to work which should have positive effects. Management noted that:
Better revenue management tools and techniques, enabled by our new reservation system, will help mitigate any competitive pressures for this year. I expect those benefits from the new system to begin in second quarter. (Source: 4Q17 Earnings Call)
We expect increased travel demand to be seen later in the year, primarily driven by the recent tax reform. Other revenue drivers for the year may stem from Southwest's efforts to open up Hawaii as a destination.
Margins continue to do very well, with their gross margin holdings steady for the most part. On the other hand, Southwest's operating margin fell ~181 bps y/y, primarily driven by higher labor costs.
Margins stand to benefit from a more fuel efficient fleet, as Southwest retires their 737 Classic's and begins using their new 737 MAX's.
Valuation
Nearly the entire airline industry trades at a fairly low valuation relative to the S&P historical average. Southwest currently trades at ~16x LTM earnings (excl. unusual items).
This is higher than their industry peers, yet below their own historical average of ~19x earnings. As performance metrics increase, we see their multiple expanding back into that range in due time.
The public comps analysis below shows how Southwest pairs up next to its peers.
Conclusion
Overall, we believe Southwest continues to be a top pick in the industry - and stands to benefit from an increase in travel demand. With several key revenue drivers into 2018, we see their top line remaining fairly safe. Management stresses focusing on the core aspect of the business, which we see as vital. Without a thriving core, any additions just do not help all that much.
Seeing as management has set a goal to expand operating margins for the year, upside in the bottom line remains. Our EPS forecast for the year is in-line with Street consensus of ~$4.91. Applying a 16x earnings multiple results in a share price of ~$79.
We initiate a buy rating, and a $79 PT.
Southwest Airlines: Cleared For Takeoff - Southwest Airlines Co. (NYSE:LUV) | Seeking Alpha
