Airlines have historically made for terrible investments. Warren Buffett famously said that “if a farsighted capitalist had been present at Kitty Hawk, he would have done his successors a huge favor by shooting Orville down.” Fortunately, a couple of airline stocks have managed to avoid bankruptcy and make their shareholders major bucks over the years. Southwest Airlines (NYSE:LUV) is the United States’ best example. An investor in LUV stock over the past 20 years has made a total return of 533% — not bad for an airline stock.
So, give management its due, it’s avoided the usual pitfalls of the airline industry. But 2018 may not be such a good year for Southwest’s investors. The company recently had a fatal crash, oil prices are spiking and its international routes are facing more competition.
Southwest Flight 1380
On April 17, Southwest Flight 1380 was forced to make an emergency landing after one of the plane’s engines exploded in flight. Tragically, the explosion was so great that the damage broke a window and almost sucked a passenger out of the cabin. Other people pulled her back in, but she later died.
At this point, it is unclear if Southwest is more at fault, or the engine makers, which includes the likes of General Electric Company (NYSE:GE). Government investigations into this sort of matter tend to take awhile.
What we do know is that this will be a reputational blow for Southwest and LUV stock. The company has given $5,000 vouchers to all the passengers on board, which is a good step. But the media impact of a fatal crash tends to linger for awhile. Expect Southwest’s earnings to be a little softer over the next couple of quarters as a few passengers choose other airlines for their flights.
For a long time, south-of-the-border flights have been a significant profit center for US non-traditional airlines such as JetBlue Airways Corporation (NASDAQ:JBLU) and Spirit Airways Incorporated (NASDAQ:SAVE) along with Southwest. But these routes are starting to get saturated. All three of those airlines have made aggressive plays internationally.
And now Mexico and Central America are bringing their own competition to the US market. Mexican carrier Volaris (NASDAQ:VLRS) has arguably been most aggressive on cross-border flights. They also recently launched Volaris Costa Rica to bring lower fares to Central America-US routes. The Viva family of carriers is backed by Europe’s dominant low-cost carrier Ryanair Holdings plc (ADR) (NASDAQ:RYAAY). This includes VivaAerobus in Mexico and VivaColombia — both of which have launched flights to the US.
Mexico’s third discounter, Interjet, has also expanded its Mexico-US flight offerings.
This is problematic for LUV stock, since all the competition is bound to drive down fares. Keep in mind that the non-US carriers have a major advantage in labor costs. Volaris, for example, has the lowest cost per mile of any carrier in all of the Americas. They’re often cheaper than buses on their Mexican domestic routes. When they get into a fare war with your airline, prices are heading much lower. Additionally, Southwest’s planned further expansion into Mexico could hit turbulence if the Mexican socialist candidate (currently up in the polls) wins their presidential election this summer.
Southwest has another problem: crude oil is soaring. Southwest famously beat the other airlines in a big way during the pre-Great Financial Crisis era due to its extensive and shrewd fuel price hedging strategy as oil shot the moon. But we’ll have to see if they have the skill to avoid the fallout from another big price spike.
Since the 2016 low at $27/barrel, oil has spiked to $68/barrel again. That’s a 150% run off the lows — in two years. Oil is rushing higher so quickly now that it’s caught Donald Trump’s attention. He tweeted Friday: “Looks like OPEC is at it again. With record amounts of oil all over the place, including the fully loaded ships at sea, oil prices are artificially very high! No good and will not be accepted!”
Of course, when Trump turns his attention to something, volatility ensues. For all we know, his actions may cause oil, and as a result jet fuel, prices to rise even further.
Unfortunately for shareholders, airlines have traditionally had a terrible time trying to raise ticket prices. One airline will try to lift their ticket prices, but if the others don’t follow, it usually has to back down. To show how tough it is to raise ticket prices, consider March fares, which rose 0.6% sequentially, but are down 6% from March 2017. And this time last year, oil was in the low $50s — now it is at $68. That math is highly corrosive to airlines’ profit margins.
LUV Stock Verdict
Southwest is a great airline, quite possibly the greatest, in the United States for investors. But that doesn’t mean the stock is automatically a buy today. In fact, quite the opposite at this time.
With a fatal crash still in the news, competition rising on the company’s international routes and oil prices surging, there is every reason to expect LUV stock to dip in 2018.
I’d wait for LUV stock to revisit support at $50 before considering putting on a bullish trade.
At the time of this writing, the author held no positions in any of the aforementioned securities. You can reach him on Twitter at @irbezek.