Southwest Airlines (LUV) stock’s strong rally on the heels of its surprise earnings report Thursday may make LUV stock appear to be a tempting buy, but investors should use caution with airline stocks, especially ones as overinflated as LUV.
Southwest stock has been a highflier since late 2013 thanks to depressed fuel prices, and LUV stock is up about 288% since January 2013.
So far this year, LUV’s gains have been more tempered — up only 3.5% year-to-date — but it’s trading up more than 7% in Thursday’s afternoon session after reporting third-quarter earnings. And while its Southwest’s earnings were impressive, don’t be lulled into a false sense of security with LUV stock.
Rundown on Southwest Earnings
LUV stock was trading up more than 7% in Thursday’s afternoon session after reporting third-quarter adjusted net income of $623 million, or 94 cents per diluted share, above analyst estimates of 92 cents, according to Capital IQ figures.
Those earnings are nearly double the 55 cents per share reported in the same quarter last year, a meaty gain many airlines have been welcoming thanks to plummeting jet fuel costs combined with increasingly efficient engines.
But Southwest also drew a substantial increase in its operating revenue, which increased 10.8% year-over-year to $5.31 billion, above the Street mark of $5.11 billion. The Dallas-based airliner wowed investors with its robust 20.3% operating margins, drawing a record $1 billion in net income, excluding special items.
For the fourth quarter, Southwest estimates fuel costs of $2.05 to $2.10 per gallon, well below the average cost of $2.62 in the fourth quarter of last year, indicating sustained improvement in earnings for the near-term at least.
Southwest is making strides toward international expansion as it launched eight new markets in August alone, including a new customs station at its Houston hub, servicing Costa Rica, Mexico City, Puerto Vallarta, Cabos and Belize.
For shareholders, LUV stock returned $180 million in dividends and repurchased $1.2 billion in stock so far this year. It recently raised its quarterly dividend to about 7 cents per share. And Southwest has a comfortable pile of cash, with cash and short-term investments totaling $3.1 billion at the end of the third quarter and free cash flow of $1.6 billion so far this year.
Bottom Line on LUV Stock
While trends in the airline industry are indeed positive, investors should remain on guard for risks in commodities trends that are beyond the airlines’ control. Crude oil futures, trading near $46 per barrel in Thursday’s session, are down 42% the past year, and many analysts believe prices will remain low for quite awhile.
But low crude oil prices are not a certainty; in fact, crude oil was trading up 1.6% Thursday.
Trading at 19 times earnings, Southwest is among the more expensive airline stocks to buy right now. Compare that to other top airline valuations: Delta Air Lines (DAL) with 14.6, United Continental Holdings (UAL) with 8 and American Airlines (AAL) with 7.9.
Indeed, Southwest’s earnings show the company is healthy and thriving airline, but LUV stock is simply not a bargain right now … especially amid an uncertain future when it comes to jet fuel costs.
As of this writing, Rebecca McClay did not hold a position in any of the aforementioned securities.