It’s always nice when you can identify a company poised to experience strong growth during the upcoming year.
It’s even better when that company is in a sector that’s been handed a huge financial boon thanks to falling oil prices.
The sector is the airline industry, and the company is Southwest Airlines Co (LUV), one of the most efficient carriers to take flight in the history of the travel industry.
Southwest Airlines got its start in 1967 a strictly in-state, local airline in Texas. The original idea was to stay within the borders and avoid federal regulation with short flights between secondary airports in Houston, San Antonio, Dallas and a couple other cities.
LUV quickly gained a low-cost advantage, utilizing only one type of aircraft on direct routes and a straightforward and simple fare structure.
Fast-forward a few decades and Southwest is now the largest airline in the U.S. with a streak of 41 consecutive years of operating profits. To put into perspective how impressive that stat is, consider that the airline industry has experienced over 180 bankruptcies since 1978!
Southwest Airlines recently won 54 new slots at Reagan National in Washington, D.C. and 12 new slots at LaGuardia in New York. Both airports are high-traffic markets that will provide excellent growth opportunities for LUV moving forward.
Most of the future growth, however, will come from overseas, as Southwest just begun international flights this past July for the first time. LUV will expand routes and frequency over the next several years.
Plus, it won’t be just top-line revenue growth driving LUV as Southwest is still working through the process of retiring the brands associated with AirTran Airways, which Southwest Airlines acquired in 2011 for $1.4 billion. Morningstar analysts believe Southwest Airlines will see considerable improvement in operating margins as it fully integrates AirTran into the fold.
Windfall From Lower Oil Prices
Fuel represents about 30% of a typical airline’s total revenues and is easily their largest cost. The dramatic drop in oil prices the past few months has yet to play out in earnings as nearly every major airline hedges out their fuel costs, including Southwest Airlines.
In a recent report, Morgan Stanley estimated that the major U.S. airlines spent close to $50 billion on fuel last year. The past few months have seen jet fuel prices crater right alongside crude oil, thus providing a tremendous windfall for the sector.
As you might expect, competition and consumer demand will dictate how much of these savings are passed on to passengers in terms of lower fares and how much goes straight to the bottom line of Southwest Airlines.
Those costs savings are on the horizon as many analysts believe the airline industry to be as little as 15% hedged this year and to be largely unhedged completely in 2016.
Just a few weeks ago, Southwest Chief Executive Gary Kelly said LUV has been adjusting its hedges against future fuel costs swings, and even accounting for losses on contracts pegged to higher prices, Southwest Airlines will probably save a minimum of $1 billion in 2015 alone.
So far, demand is holding up well. Southwest recently reported fourth-quarter traffic results that showed a 1% – 2% increase in revenue per available seat mile versus a year ago. Additionally, Southwest Airlines’ traffic grew 4.3% on capacity expansion of 2.4%, resulting in improved seat utilization.
LUV stock continues to trade at just 13 times next year’s earnings, well below that of the S&P 500 while continuing to maintain an excellent balance sheet. It’s a perfect storm of decreasing expenses and potential revenue growth that has us excited about Southwest Airlines. LUV is in the air.
Jon Markman operates the investment firm Markman Capital Insights. He also offers a daily trading advisory service, Trader’s Advantage, and CounterPoint Options, a service that helps individual traders make steady, consistent profits with volatility-related instruments.
