Southwest Airlines Co (NYSE:LUV) shares tanked on Thursday, and in the grand scheme of things, it’s not terribly surprising.
Though Southwest topped its fourth quarter revenue and earnings estimates, the entire industry — from major names like American Airlines Group Inc (NASDAQ:AAL) to the smaller outfits like Alaska Air Group, Inc. (NYSE:ALK) are still reeling from yesterday’s news. United Continental Holdings Inc (NYSE:UAL) has announced that it’s planning a major expansion. And now, a profit-gouging price war could be in the cards.
Still, for investors that can look beyond the fog of hysterical headlines and put their finger on the true pulse of the air-travel market, this is an opportunity. Thursday’s follow-up dip from Wednesday’s 5% setback could make this a great time to step into underestimated LUV shares.
Southwest Airlines Earnings
For the quarter ending in December, Southwest turned $5.27 billion worth of revenue into a per-share operating profit of 77 cents. Prior to the report, analysts were collectively expecting a per-share profit of 77 cents on revenue of $5.25 billion. Both figures also compare favorably to the year-earlier quarter, when Southwest Airlines drove $5.08 billion in sales and posted a profit of 75 cents per share.
Though the average fare per passenger was down nearly 3%, in light of the circumstances that’s actually a fairly healthy outcome.
While hurricanes Harvey and Irma hit during the third fiscal quarter of the year, the impact — stifled commerce — lingered. Further slowing things down for the company during calendar Q4 was a winter weather season — though this one wasn’t quite as bad as the last quarter of 2016 — and a computer foul-up in November that was not debilitating, but embarrassing.
It wasn’t embarrassing enough to keep passengers from flying, however.
In December, the airline ferried a total of 11.08 million revenue-bearing passengers, up 4.9% from 2016, and revenue passenger miles grew 2.6%. Load factor was up 70 basis points, to 83.3%. For the whole quarter, the 2.0% increase in seat-miles for sale translated into a 1.2% improvement in operating revenues per seat. On average, Southwest’s planes were 85% full for Q4.
For the full year, Southwest earned a record-breaking $3.49 billion, up from 2016’s bottom line of $2.24 billion.
None of it really mattered, however, with United Continental’s expansion bearing down.
State of the Industry
On the surface, Wednesday’s announcement from United is good reason for concern. More competition is never a good thing for any of the players in a market. But there are two things to consider that oppose the market’s bearish knee-jerk response.
First, United Continental may simply be ramping up its capacity in step with new demand rooted in global economic strength and greater accessibility to air travel all over the world. Aircraft maker Boeing Co (NYSE:BA) says the air travel market in 2037 will be 2.5 times larger than it is now as infrastructure is built and consumers are better able to afford flying. With a larger market for everyone, an expanded United Continental is not quite as scary.
Second, when United President Scott Kirby commented on the expansion, he said:
“The best way to compete with a low-cost carrier is matching prices. No one chooses to fly on an ultra-low-cost carrier if they can get the same price on United Airlines, nobody.”
He may be right, but it’s far from a sure thing.
There’s little doubt that Kirby’s comments are at least partially aimed at Southwest Airlines, which is the most recognizable name among consumers on the low-cost air travel space. What investors need to consider, however, is that Southwest is already operating as a discount carrier. So it has experience running lean. United Continental is trying to become a low-cost airline, but it’s difficult to break old habits.
Said in simpler terms, Southwest can do “cheap” already. United has to learn how.
So Southwest is not apt to lose much, if any, market share, and a price war will hurt Southwest the least among the major names.
Bottom Line for LUV Stock
In the short run, LUV shareholders clearly still see the glass as half empty rather than half full. But that’s because headlines and hysteria drive stocks in the short run.
Given enough time though, stocks reflect their underlying value. And LUV stock still has plenty of it, regardless of Thursday’s response to Q4 numbers.
In my opinion, investors are in the process of throwing the baby out with the bathwater.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities. You can follow him on Twitter, at @jbrumley.
