Southwest Airlines Co Stock Is Cheaper Than You Think


LUV stock - Southwest Airlines Co Stock Is Cheaper Than You Think

Source: Jerry Landers via Flickr (Modified)

A couple of tidbits of information caught my eye recently while evaluating Southwest Airlines Co (NYSE:LUV) and LUV stock against its major peers.

First, InvestorPlace’s Dana Blankenhorn cautioned airline investors in his March article about Delta Airlines, Inc.’s (NYSE:DAL) cheapness, suggesting it isn’t a healthy sign when the company’s price-earnings ratio shrinks to 11 while dividends have more than tripled over the last three years from 9 cents in May 2015 to 30 cents on March 16.

In Blankenhorn’s opinion, Delta has become a stock for income investors.

But it’s so cheap?

In a more recent article from April 6, InvestorPlace options expert Nicolas Chahine laid out a play for Delta based on the stock’s recent correction. Buy on the dip and all that.

“Fundamentally, DAL is cheap, trading at 10 trailing price-to-earnings ratio. This is cheap in absolute terms and relative to its competitors,” stated Chahine. “Price-to-book is under 3, so owning its stock is not likely to be a financial disaster.”

There’s that word “cheap” again.

What About LUV Stock?

They say timing is everything.

At the end of January, I suggested LUV stock was a buy — even at levels above $60. Well, we know what happened next. The markets turned volatile and Southwest warned at the end of March that revenue per available seat mile (RASM) wouldn’t grow in the quarter, down from its original guidance of 1%-2% growth.

Let’s face it: The easy pickings have been gobbled up by all the big airlines, including Southwest. The next 12-24 months are going to be much more competitive — and I say that in a bad sense if you’re an investor —  than they were in the past two or three years.

Revenues might be higher due to increased capacity, but profits will be lower due to higher costs and lower prices.

If Warren Buffett does buy an airline, 2019 might be the perfect time to do it when profits are down and airlines more vulnerable. I don’t see it happening in 2018, although if you want to talk about cheap, Southwest actually could be a better bet than Delta.

Here’s why:

LUV Stock and Free Cash Flow 

A quick Google comparison of Delta and Southwest’s P/E ratios shows a wide difference between the two with the former at 10.2 times earnings while the latter chimes in at 15.9 times earnings.

By this financial metric, Delta’s considerably cheaper. Earlier, my colleague mentioned Delta having a price-to-book ratio below 3 — it’s currently 2.7 — while Southwest is trading at 3.1 times book, so Delta’s cheaper by this financial metric as well. Same thing for the price to sales and price to cash flow.

Game over, right? Wrong.

Don’t forget free cash flow yield. Cash is king, especially in a more turbulent operating environment like the one that airlines are expected to face.

Delta’s FCF yield is 4.5% based on $1.97 billion in free cash flow and an enterprise value of $44.3 billion.

Southwest’s FCF Yield is 5.5% based on $1.8 billion in free cash flow and an enterprise value of $32.9 billion.

For truly cheap stocks, you want FCF yield higher than 8%, but I think you get my drift.

Bottom Line on LUV Stock

I recently called Southwest one of the seven transportation stocks that drives the American economy.

Ever since the days Herb Kelleher ran the airline, I’ve felt like Southwest is in a league of its own.

Southwest isn’t dirt cheap by any means, but for those of you who see Delta as the cheaper stock, you might want to consider which airline is the better operator in times of economic difficulty.

That’s Southwest in a walk.

As of this writing Will Ashworth did not hold a position in any of the aforementioned securities.

Will Ashworth has written about investments full-time since 2008. Publications where he’s appeared include InvestorPlace, The Motley Fool Canada, Investopedia, Kiplinger, and several others in both the U.S. and Canada. He particularly enjoys creating model portfolios that stand the test of time. He lives in Halifax, Nova Scotia.

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