Airline Stocks Remain Grounded…Except One

by Lawrence Meyers | January 26, 2012 7:30 am

Question: Why on earth would you want to buy an airline stock? Answer: You wouldn’t. Except for one.

That’s because airlines have an awful business model. If oil prices go up, the cost of flying the jets goes up even more, requiring carriers to hedge, which distracts them from what they should be doing: transportation.

Then there’s the economy. When it tanks, airlines tank along with it. These companies require tons of capital spending to maintain their airplanes. And because of the tragedy of September 11, a business known for crappy customer service has become even worse, thanks to the TSA’s ridiculous airport security processes.

So, how is it that Southwest Airlines (NYSE:LUV[1]) is the only airline that’s doing well financially and always scores near the top of customer satisfaction lists?

It’s because management has understood from the start how to run an airline efficiently. It has a different strategy of flying into secondary airports. It has more flexibility in its purchase and exchange options. It has a corporate culture that makes employees feel like partners, and that culture transfers all the way down to the workers who make the flights (almost) bearable. Despite being 80% unionized, the airline has never had a labor action. Finally, Southwest’s marketing wisely focuses on selling freedom, not selling what everyone else does — flying.

It’s safe to say that, after more than 30 years, Southwest’s strategy is working. Even when its quarterly numbers aren’t stellar, there’s still plenty to like. Per-gallon fuel costs went crazy — up 34% year-over-year. But because Southwest runs an airline most people actually like, it was able to offset most of that with its pricing power: It boosted its average fare by 7%.

Because the airline is strategically smart, and because it has the financial ability to act in support of smart moves, it’s able to upgrade its fleet to more fuel-efficient aircraft in the face of these high oil prices. But Southwest is wisely not expanding that fleet until it hits internal profit targets. Instead, it will concentrate on boosting unit revenue performance.

The result? While American Airlines just filed for bankruptcy and other competitors continue to struggle, often losing money, Southwest just had its 39th consecutive year of profit. For an airline, that’s amazing. You know what’s even more amazing? The company has $3.1 billion in cash — and the same in debt. In contrast, competitors are crushed under tons of debt.

It’s difficult to value an airline based on things like the P/E ratio. Instead, I prefer to look at the enterprise value (EV) to EBITDA ratio. Southwest is at 5. JetBlue (NASDAQ:JBLU[2]) and Delta (NYSE:DAL[3]) are at 6. United Continental (NYSE:UAL[4]) is at 2.8, but it carries $5 billion in net debt and has historically had vastly inferior margins to Southwest.

Southwest is trading at $9.55, which is 60% off its all-time high. That’s the kind of sale price that would make folks jump at an airline ticket and, in this case, at the stock.

Lawrence Meyers does not hold shares in any company mentioned.

Endnotes:
  1. LUV: http://studio-5.financialcontent.com/investplace/quote?Symbol=LUV
  2. JBLU: http://studio-5.financialcontent.com/investplace/quote?Symbol=JBLU
  3. DAL: http://studio-5.financialcontent.com/investplace/quote?Symbol=DAL
  4. UAL: http://studio-5.financialcontent.com/investplace/quote?Symbol=UAL

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