On the heels of an air travel bounce back, Southwest Airlines (NYSE:LUV) has made an epic recovery as of late. Since May 15, shares have rallied tremendously. But, with LUV stock up more than 60% in less than a month, is it too late for investors to buy in as the stock remains below past highs?
It’s debatable. On one hand, low-cost carriers like this company may be the better airline plays out there. Not saddled with high operating costs and pension liabilities like its rivals, once passengers return to the skies, Southwest could more quickly return to profitability.
On the other hand, speculation has gotten ahead of fundamentals. Investors have bid up airline stocks across the board. Investors have also piled into airline exchange-traded funds like the U.S. Global Jets ETF (NYSEARCA:JETS). With so many people looking to bet on a V-shaped airline recovery post-novel coronavirus, it’s no surprise this has happened. Even with just breadcrumbs of good news backing up the thesis.
The question is whether results will live up to high expectations for clear skies ahead. With this in mind, it may be too late to ride the wave with LUV stock. Nevertheless, with an operating model giving them an edge, shares could be a buy on a pullback.
Low-Cost Model Gives Southwest an Edge Over Legacy Rivals
Should you buy legacy carriers with a lot of baggage, like American Airlines (NASDAQ:AAL)? Or should you consider financially stronger names, like Southwest? The answer is crystal clear.
If you want to bet on a full airline recovery, go with quality. And that’s the situation with LUV stock. As InvestorPlace’s Will Ashworth wrote June 1, this airline has a much cleaner balance sheet. Also, given this carrier’s focus on domestic routes, they have less to lose if travelers continue to shun international flights due to mask-wearing requirements and other safety protocols that make a long-haul flight less appealing.
Besides these advantages, Southwest has another edge over the “old school” airlines. That would be their low-cost structure. Obviously, this has been a decades-long advantage for them. Yet, today’s enviornment could make it an even greater strength.
How so? With lower operating costs, the carrier can better adapt to what CEO Gary Kelley deemed a “brutal low-fare environment” going forward. This could mean they have a better chance at returning to profitability, even as safety measures and low demand impact load factors.
Add in a recently announced employee buyout package, and the carrier can reduce its operating costs further. In short, the large but low-cost carrier could not just survive, but thrive in the “new normal.”
Yet, all of this is well known. The recent run-up factors this into the share price. And then some. With this in mind, there’s good reason why shares could head lower in the short-term.
What Could Sink LUV Stock in the Near-Term?
In my prior Southwest write-up, I was quite bearish on their near-term prospects. But while markets have proved me wrong as of late, there are risks to consider before diving into this stock.
Granted, the company’s capital raises during the pandemic will help minimize the impact of their current $30 million to $35 million daily cash burn. Yet, what happens if unprofitably continues, even as passengers start returning to the skies this summer? With the recent run-up in shares, investors have priced in too much, too soon.
Even if the forecast for air travel is less dire than it was a few weeks ago, it’s still a long road to rebound. The company itself doesn’t see a recovery until six to twelve months from now. In short, if investors buying today see that actual results this summer fall short of V-shaped expectations, shares could pull back from today’s “too hot to touch” prices.
Also, a rapid recovery for airlines is contingent on an economy firing on all cylinders again. But, tough times could continue. Even as the pandemic enters the rearview mirror. As InvestorPlace’s Josh Enomoto wrote May 22, job losses may be shifting from service-economy workers to middle class professionals. Add in concerns of weak consumer spending, and it’s tough to see discretionary purchases (like air travel) bouncing back as quickly as the stock market assumes.
Wait for a Pullback Before Diving Into Southwest
Given how airlines stocks have performed in the past week, you may be afraid of missing out, and want to dive into names like this company. But, weighing the carrier’s relative strength against economic uncertainty, joining the crowd may not be the best move right now.
So, what’s the play? Sit tight for now, but consider LUV stock a buy if it pulls back from today’s prices.
Thomas Niel, contributor to InvestorPlace, has written single-stock analysis since 2016. As of this writing, he did not hold a position in any of the aforementioned securities.
