Memorial Day is the traditional start to summer traveling season, but this year the novel coronavirus has people staying home. As the economy slowly opens, investors are wondering if June could be a good time to invest in airline stocks. Year-to-date, Southwest Airlines (NYSE:LUV) stock is down over 37%, hovering around $33.
In any given year, the global airline industry faces a large number of risks, such as volatile and rising fuel prices, political uncertainty, an economic downturn in any given region, and foreign exchange risks.
It is also a highly competitive industry. 2020 has added a new risk factor, i.e., the unexpected global pandemic and the ensuing global lockdown.
By now consumers and investors alike know that travel companies, especially airlines, are hurting. If you are an investor with two- to three-year time frame, then you may consider buying the dips in the largest low-cost carrier worldwide.
Here’s why I believe Southwest Airlines and LUV stock will likely navigate the current winds successfully.
A Look at Q1 Results for LUV Stock
Most of Southwest’s network is domestically located. On April 28, the Dallas-based airline reported first-quarter 2020 results that marked the company’s first quarterly loss since 2011. LUV posted a loss of $94 million in the quarter on revenue of $4.23 billion. Sales declined 18% from the previous year.
Before the viral outbreak hit our shores, management had returned of $639 million to shareholders through LUV stock buybacks and dividends. However, dividends and share repurchase programs have been suspended until further notice.
Like other airlines, Southwest also reached an agreement in principle with the U.S. Treasury to participate in the support program through the CARES Act.
The group will get $2.3 billion in direct payroll support and $948 million in the form of an unsecured 10-year term loan. In return it will issue warrants to enable the U.S. Treasury to purchase up to 2.6 million shares LUV stock.
Management now expects revenue in May to fall as much as 95% from a year earlier. Put another way, second-quarter results that are due in July will likely to be worse than the first.
Long-Term Tailwinds for LUV Stock
In the U.S., the airline industry was deregulated in the late 1970s. In the years that followed, Southwest Airlines pioneered the low-cost business model. And its growth shows how successful management has been in executing its pricing plans as well as route and fleet management.
That’s something CEO Gary Kelly talked about in the Q1 earnings release:
“We are currently the only U.S. airline with an investment-grade rating by all three rating agencies and remain focused on maintaining a strong balance sheet. We entered this crisis prepared with the U.S. airline industry’s strongest balance sheet and most successful business model.”
This financial strength is one of the greatest assets that the airline has during this difficult time.
The group is also counting on the U.S. consumer to start flying again. For months, many people have been home with hardly any reason or even possibility to travel.
Kelly is willing to bet on the passengers. “While the impact of the pandemic is unprecedented, we believe demand for air travel will rebound,” he said. “And, we intend to emerge with ample liquidity and an unwavering focus on our enduring purpose — to connect people to what is important in their lives through friendly, reliable, and low-cost air travel.”
Despite the real challenges of 2020, the company’s fundamental story remains intact both thanks to Southwest management’s commitment to growth and financial discipline. Finally, stable or even lower fuel prices in 2020 and beyond could further contribute to the airline’s bottom line.
What Could Derail LUV Stock Further
The factors that are likely help LUV stock price in the long run could also become short-term headwinds. Although airline management is hopeful that it will be able to fly again soon, both Southwest and its peers need to ensure that scheduled flights remain profitable.
According to recent research in Travel Medicine and Infectious Disease, “air travel has never been easier, cheaper or faster, with large volumes of people travelling around the world. These factors increase the risk of the spread of infectious diseases by air travel.”
Therefore, Southwest will be working hard to ensure consumers feel confident to fly again. If consumer demand does not return in a manner that makes flying profitable for Southwest, then LUV stock may not be able to take off.
Summer travel season is in general an airline’s most lucrative time of year. And management is hoping to cash in on the possibility that consumers are ready to fly again.
Operating an airline is expensive. Airlines need to keep a close eye on their cash balances. In difficult times such as now, they also need to be able to minimize cash burn and raise enough cash to weather the winds. For the second quarter Southwest management expects the daily cash burn to be around $30-$35 million. Therefore, the number of passengers in the summer will likely show how the rest of the year may be for Southwest’s fundamental metrics.
The shares started 2020 around $55. But on May 14, LUV stock hit a 52-week low of $22.47. Now it is hovering around $33. If Southwest as well as other airlines cannot start flying in the coming weeks in a profitable manner, then LUV shares can easily go below $30 again.
Investor Takeaway on LUV Stock
Do you “LUV” flying? As economies open up and a somewhat lighter mood returns to our lives, passengers may be able to take it to the blue skies again in the summer.
U.S. airlines are facing tough times. Investors should weigh all these factors when they determine individual portfolio allocations and risk/return profiles.
June may bring further volatility to the stock market and I would not advocate bottom-picking. Yet I’d look to buy LUV stock between $27.50 to $30 and expect to hold it for several years.
Organizations face crises regularly. In the long run, I am hopeful that Southwest management will be able to turn the current difficulty into opportunity both for the airline and investors in LUV shares. I am encouraged by its proactive management, business model, and strong capitalization.
Tezcan Gecgil has worked in investment management for over two decades in the U.S. and U.K. In addition to formal higher education in the field, she has also completed all 3 levels of the Chartered Market Technician (CMT) examination. Her passion is for options trading based on technical analysis of fundamentally strong companies. She especially enjoys setting up weekly covered calls for income generation. As of this writing, Tezcan Gecgil did not hold a position in any of the aforementioned securities.
