Throughout March and April, Southwest Airlines (NYSE:LUV) was grounded by the novel coronavirus pandemic – formally dubbed Covid-19. But, in mid-May, LUV stock started to rebound in a big way on three big signals.
First, the U.S. economy started reopening. Second, consumer behavior started normalizing. Third, U.S. air traffic levels started meaningfully rebounding.
Sure, this big recovery rally in LUV stock has been short-circuited by fears of a “second wave” of Covid-19, thanks to rising case numbers and hospitalizations in certain U.S. states.
However, in the big picture, a “second wave” of Covid-19 will not kill LUV stock.
Instead, the U.S. economy will continue to gradually reopen over the next few months. At the same time, consumer behavior will keep normalizing and air traffic levels will keep rebounding.
A second wave won’t change any of that – so with LUV stock dropping recently on second wave concerns, I say buy the dip.
Here’s a deeper look at why.
A Second Wave Won’t Kill the Recovery
A second wave of Covid-19 won’t permanently kill the U.S. economic recovery, or the rebound in air travel, or the rally in LUV stock.
Instead, a second wave will simply slow all three of those things, before passing and doing nothing more.
Why? Because U.S. consumers have made up their mind that they can simultaneously live their lives and mitigate virus risks with things like social distancing and mask-wearing.
That is, back in February and March, we didn’t really know what we were dealing with when it came to Covid-19. Since then, though, we’ve had five months of scientists learning about the virus and consumers living around the virus. Those scientists have discovered that the virus isn’t all that deadly and very low-risk for the under-60-year-old crowd, while those consumers have discovered that they can go to beaches, restaurants and malls without getting violently ill, or even sick at all.
So long as this remains true – i.e. the science continues to shine a favorable light on the virus, and the majority of consumers continue to not contract the virus – then consumers will keep going out and powering an economic rebound, even in the face of a second wave.
Air Travel Is Recovering
Naturally, sustained consumer behavior normalization lays the groundwork for air travel trends to continue to improve.
From its mid-April lows to mid-June, TSA recorded total traveler throughput at airports has risen more than 500%. Sure, total traveler throughput is still down 79% year-over-year as of mid-June. But that’s up from 90%+ declines throughout April and May, and represents the first time that the year-over-year decline has been less than 80% since March 21.
These numbers will keep getting better over the next few months. As they do, LUV stock – alongside all other airline stocks – will get back into rally mode.
LUV Stock Has Upside Potential
My numbers indicate that Southwest stock has upside potential to levels above $40 in the near future.
Here’s the math:
- Powered by rebounding consumer demand and a potential vaccine in 2021, global air traffic levels will almost fully normalize by 2022.
- Southwest’s revenues were around $22.4 billion in 2019. Of those, 97% were from low-cost, domestic flights. Low-cost, domestic flight traffic will recover and normalize more quickly than premium, international flight traffic. Consequently, if global air traffic levels almost fully normalize by 2022, then Southwest’s traffic levels should entirely normalize by then, implying $22+ billion in 2022 revenues.
- Southwest’s operating margins were north of 13% in 2019. Operating margins will like never get that high ever again, because of additional costs from more thorough and consistent cleaning measures. To that end, Southwest’s 2022 operating margins could come in around 10%.
On those assumptions, I’m modeling for Southwest to net $3.50 in earnings per share by 2022. Based on a historically average 12-times forward earnings multiple, that equates to a 2021 price target for LUV stock of more than $40.
Bottom Line on LUV Stock
The rebound in air travel and Southwest flight demand has arrived. It’s not going anywhere anytime soon. Not even a second wave of Covid-19 can derail this recovery. Consequently, any and all weakness in LUV stock today is a longer-term buying opportunity.
Powered by rebounding air travel demand, this stock will claw its way back to all-time highs over the next few years.
Luke Lango is a Markets Analyst for InvestorPlace. He has been professionally analyzing stocks for several years, previously working at various hedge funds and currently running his own investment fund in San Diego. A Caltech graduate, Luke has consistently been rated one of the world’s top stock pickers by various other analysts and platforms, and has developed a reputation for leveraging his technology background to identify growth stocks that deliver outstanding returns. Luke is also the founder of Fantastic, a social discovery company backed by an LA-based internet venture firm. As of this writing, he did not hold a position in any of the aforementioned securities.
