Southwest Airlines (NYSE:LUV) has been among the best performers when it comes to the airline stocks. While LUV stock may not have rallied as hard as some of its peers over the last week, its share price has lost the least amount of altitude amid the selloff.
We’re at a very interesting crossroads, not just with Southwest but with the entire industry. On the one hand, most of these stocks deserved to sell off. Revenue plunged as airline traffic fell more than 90% at the lows. With little revenue coming in, Southwest and other airlines still had ongoing costs.
This flipped the bottom line from positive to negative and crushed free cash flow. Worse, Q2 (the current quarter) and Q3 tend to be most airlines’ best quarters when it comes to revenue and free cash flow.
But there’s a reason Southwest Airlines has outperformed its peers. Let’s have a closer look.
Valuing LUV Stock
From its 2020 high, LUV stock is currently down 44%. That includes the 11% spill it took on June 11, as the overall market was hit hard.
While a 44% decline is nothing to brag about, it’s certainly better than the 53% fall in American Airlines (NASDAQ:AAL) and the 56% dip in Delta Air Lines (NYSE:DAL). It’s significantly better than the 63% selloff in United Airlines (NASDAQ:UAL).
So why has Southwest been able to perform so much better than its peers? Put simply, its balance sheet is better than its peers. With less leverage and a more conservative approach, it’s on better financial footing in these tumultuous times.
As airline traffic begins to return, investors are hoping Southwest can ride these strong financials to more prosperous times. In speaking with InvestorPlace, Dirk Hackbarth, professor of Finance at Boston University Questrom School of Business, had this to say about Southwest and its peers:
“The airline industry is [a] debt-ridden industry because it has fixed obligations from bonds, loans, etc. as well as airplane lease agreements; the latter are presumably similar across firms.
“While Delta Air Lines exhibits an average financial leverage policy, Southwest Airlines appears to be the most conservative one with leverage below the airline industry’s average along with different measures of financial risk. United Airlines Holdings and especially American Airlines Group have the highest financial risk.”
For airlines, the problem is the rebound. Just how fast will the industry return to pre-coronavirus capacity?
Estimates call for a halving of Southwest’s revenue from $22.4 billion last year to $10.75 billion this year. That’s alongside a 200% decline in earnings, with forecasts calling for a swing from $4.45 per share in profit in 2019 to a $4.62 per share loss in 2020.
Next year, estimates call for sales of just $18.1 billion and for earnings of $2.01 per share. That’s not a bad rebound, but if these estimates are even close to accurate, it tells us the recovery back to pre-coronavirus levels will take years, not quarters.
Trading Southwest Stock
Two things make LUV stock a difficult proposition for investors. The first is the slow recovery in the business, which we just highlighted. The other is the valuation. Southwest Airlines — and all the airlines for that matter — never commanded a high valuation.
In the current environment, the valuations may seem high because earnings have plunged. But make no mistake about it, if investors weren’t willing to pay a premium during good times, they’re certainly not going to in bad times.
Also making LUV stock difficult has been the rebound. At its recent high, shares were up 88% from the lows, a move that took just 15 trading sessions to play out.
On the plus side, shares have declined in three straight sessions and investors now have a better idea of the technical setup. For instance, $42 is clear resistance, while $30 will hopefully be support should the stock test down into this mark. If it does, Southwest can also fill the gap from May.
The moves have been so extreme in this group that I wouldn’t put too much faith in any one level holding. Near $31 is the 50-day moving average, as is the 23.6% retracement. So this $30 to $31 area could be a decent level to measure against, provided bulls have the discipline to cut LUV stock should support fail.
On a rebound, let’s see if a retest of the 100-day moving average is possible near $40.
Bret Kenwell is the manager and author of Future Blue Chips and is on Twitter @BretKenwell. As of this writing, Bret Kenwell did not hold a position in any of the aforementioned securities.
