Traffic Outlook Sends Southwest Into a Tailspin (LUV)

Just one day after Southwest Airlines (LUV), along with many other airline stocks, reached record highs on the prospect of sustained low oil prices, LUV shares were grounded today following reports that revenue wouldn’t be as strong as expected for the current quarter.

Traffic Outlook Sends Southwest Into a Tailspin (LUV)The 8% plunge LUV stock suffered Tuesday materialized despite a couple of encouraging numbers from the November traffic report, though shares are still up 10% year-to-date even with Tuesday’s drubbing.

Regardless, LUV is also still overbought and ripe for a pullback if Southwest Airlines can’t figure out how to best capitalize on uber-cheap oil prices.

The Good and the Bad

The Good: Southwest Airlines saw nearly a 14% year-over-year improvement in revenue passenger miles last month, with that total reaching 9.7 billion miles. The airline had to add capacity to muster that growth, but it did so efficiently.

Available seat miles ramped up 9.7% to 11.7 billion. That translated into a load factor of 83.2% vs. only 80.1% for the same month a year earlier.

In fact, November’s capacity usage of 83.2% was a record for that particular month of the year. Last week, Alaska Air (ALK) reported a similar, proportional scale-up in total traffic and capacity. Ditto for Delta (DAL), which saw a 4.6% increase in total revenue passenger miles on a mere 0.3% increase in available seats, confirming Southwest’s metrics weren’t a fluke.

The Bad: The beefed up capacity — and usage of it — isn’t creating as much revenue growth as investors were hoping. In some regard, it’s almost unfair for investors to penalize LUV based on the other forecasted metrics Southwest Airlines offered this morning — its operating revenue per available seat mile. Which the Southwest believes will come in flat to slightly negative.

What’s not appreciated, though, is the fact that even with flat RASM rates for the fourth quarter, revenue can still grow because the total number of available seats to sell has grown. Southwest is simply selling those tickets more or less at year-ago prices. It’s still selling more tickets, though.

Regardless, the market wasn’t impressed, as expectations of higher fares per seat — fueled by broad economic strength — has been a big piece of the reason airline stocks have been moving higher since 2013.

Cheap Fuel Prices: Blessing or Curse?

It’s a bit counterintuitive, but cheap oil (and therefore cheap jet fuel) has proven to be as much of a headwind for airlines as it’s been a tailwind.

The challenge lies in other airlines, which are enjoying the same low fuel costs LUV is. In an effort to win market share, airlines offer lower fares than their competition, which in turn forces that competition to drop their prices.

So as is the case when oil prices are at the other end of the cost spectrum, winning market share in the air travel arena eventually becomes a matter/contest of which carrier is willing to take the least amount of money per mile. That’s why Southwest’s revenue per seat isn’t poised to improve in Q4 — airlines are still acting fiercely competitive.

Or as Southwest CEO Gary Kelley put it in an interview on Fox Business News, “It’s still a very competitive environment out there [and] fares are a little softer than what we thought they would be for the quarter …we’re having to work a little bit harder to attract customers.”

Still, investors can take comfort in the fact that the capacity additions are helping the top and bottom line. Total revenue for the current quarter is projected to grow 9.3% on a year-over-year basis, to $5.06 billion. Profits per share of LUV are expected to rise from the year-ago tally of 59 cents to 92 cents this time around, largely aided by the unusually low cost of jet fuel.

Bottom Line for LUV Stock

None of this is to say LUV is a bulletproof buy after today’s 8% drop. There are still plenty of items the airline needs to address, perhaps beginning with an honest assessment of how much capacity it needs and a little thought as to what the books will look like once crude oil prices to start to recover.

It also doesn’t help that LUV shares are technically overbought right now.

But with the stock’s current pullback at least pushing it back to lower levels, at the very least it’s a name worth adding to watchlists. A move back under $41 would make for a palatable entry point, particularly if the rhetoric turns decidedly bearish … then a contrarian buy it is.

As of this writing, James Brumley did not hold a position in any of the aforementioned securities.

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