Southwest Airlines (NYSE:LUV) is slowly turning around, along with the other major airlines. I think the company has gone past an inflection point, and, as a result, LUV stock is now a winning turnaround play. But it may be worthwhile to wait a while. More on this later.
For example, on May 26, the company provided a positive update on its bookings, revenue and load factors. It showed that Southwest is now finally reaching net positive bookings. Cancellations no longer outpace new bookings.
Moreover, revenues are performing slightly less bad than last year. And lastly, load factors have significantly improved from April’s dire 5-10% levels to 25-30% in June.
Southwest has Excellent Cash Burn and Liquidity
Southwest stock has a market value of $21.5 billion. It is now a major airline. Moreover, it has a long history of producing better profits than its peers.
This reputation has carried over to its liquidity and cash burn situation at the present. For example, on the update, Southwest pointed out that its daily core cash burn will be down to $20 million in June. This is half of rivals American Airlines (NASDAQ:AAL) and Delta Air Lines (NYSE:DAL), which are expecting to run $40 million per day in daily cash burn by the end of June.
Right now, Southwest is the only major airline with an investment-grade rating by all three rating agencies. It has cash and liquidity to last 20 months without positive cash free cash flow. Most airlines are expecting that to occur by the end of 2020.
Moreover, Southwest has more than $13 billion in cash and investments, plus $7.5 in unencumbered assets. This is plenty enough to last to the end of the year.
So, it looks like the carrier will survive. Investors are no longer concerned about this. They see airport traffic picking up. Earnings prospects are also improving dramatically.
Higher Earnings Projections
Sixteen analysts polled by Seeking Alpha estimate that Southwest’s earnings per share will be $2.50 by the end of 2021. So that means that as of June 12, LUV stock, at $35.87, is trading at a forward P/E ratio of just over 14 times earnings in 2021.
That is a very positive estimate for the stock. If you think about it, though, this is nowhere near where the stock used to be valued. For example, Value Line, on its page on LUV stock, estimates that the stock has had an average P/E of between 11x and 17x earnings in the past five years.
Moreover, EPS reached $4.45 in 2019, so the projected earnings of $2.50 in 2021 could go higher. As travel demand rebounds and returns to normal, load factors and profitability will increase.
For example, even if the company got to 80% of its peak profitability, EPS could rise further. It could climb another 44% to $3.60 per share over the expected $2.50 EPS level in 2021. That would take LUV stock even further than it already has gone.
Analysts Change Opinions
Bloomberg reported on June 12 that Credit Suisse published a very positive report on Southwest Airlines. Analyst Jose Caiado De Sousa said the company would have an “aggressive comeback.” He changed his recommendation to the Wall Street equivalent of a “Buy.”
He also raised his target price to $45 per share, which would be a potential gain of more than 25%. Moreover, he believes the company is the best positioned in terms of liquidity and any rise in demand for leisure travel.
Barron’s calls Southwest’s balance sheet a “war chest” … whatever that means. The piece goes on to shed less-favorable light on United Airlines (NASDAQ:UAL) and American. Delta is a better opportunity, according to the same Credit Suisse analyst that Barron’s was reviewing.
What to Do With LUV Stock
Investors should keep in mind that all airline stocks will likely trade together up and down as a group. Some may go further higher, like LUV stock, on positive days. But, it seems to me, they will have all the same direction as a group.
You can do two things with that information: Maybe you might like to buy an airline stock exchange-trade fund like U.S. Global Jets ETF (NYSEARCA:JETS). Or, you could buy a group of such stocks.
But here is one risk with this whole strategy. Gary Kelly, Southwest’s CEO, recently told Bloomberg that he expects to see a “brutal” price war. Once coronavirus fears subside and people begin to fly again, he suspects that a low-fare competition environment will spring up among airlines.
Southwest has a strategy for how to survive during that phase. They expect to keep their capacity very low. That way their load factors and profitability per flight will be high.
But here is the downside. If a price war ensues, don’t expect LUV stock or any of the airline stocks to continue to move up. You will likely have another chance for a bite at the proverbial apple. There will be plenty of time to buy LUV stock to play its rebound.
As of this writing, Mark Hake, CFA does not hold a position in any of the aforementioned securities. Mark Hake runs the Total Yield Value Guide which you can review here.
