The big post-pandemic rally in Southwest Airlines (NYSE:LUV) stock has been short-circuited in July by spiking novel coronavirus cases across the U.S., which have in turn led to plateauing demand for domestic air travel.
Specifically, after rebounding sharply from ~$20 in mid-May to ~$40 by early June, LUV stock has since reversed course again and dropped back to $30 over the past two months.
The reality in America is that, until a Covid-19 vaccine is broadly administered, spread of the virus will likely remain vigorous, domestic air travel demand will remain depressed and LUV stock will fail to rebound.
But a Covid-19 vaccine could be just around the corner.
And if we get the so-called “October surprise,” wherein a Covid-19 vaccine scores FDA approval as early as October, then LUV stock will fly higher.
I think that’s entirely possible. I think a vaccine will score FDA approval by either October or November, and that LUV stock will soar to levels above $40 by the end of 2021.
If you agree, buy LUV stock. Today. Before this big “October surprise” rally.
Here’s a deeper look.
A Covid-19 Vaccine in October?
I think the base case scenario for a Covid-19 vaccine is that we get at least one vaccine (and maybe multiple) approved by October or November, and broad population distribution of those vaccines by early 2021.
My bullishness here comes to down a few things.
One, the world has put all of its resources into finding a vaccine. And the result is that we now have over 140 pre-clinical Covid-19 vaccines out there, 19 Covid-19 vaccines in Phase I trials, 12 vaccines in Phase II trials and 5 vaccines in Phase III trials.
In other words, the world put all of its resources into finding a Covid-19 vaccine. We now have several which look like they are on the cusp of being approved. That’s the power of human innovation. And human innovation has a long, several-thousand-year track record of trumping crisis after crisis.
Two, health experts are now starting to say that October/November vaccine approval is both plausible and even likely. Most notably, Dr. Anthony Fauci, who is widely perceived as the world’s foremost authority on Covid-19, recently said that a Covid-19 vaccine is possible in October, and likely in November.
Three, mass production of a vaccine has already started. Pretty much everyone, ranging from the companies making the vaccines to the U.S. government, believes that we will have, at least, several hundred million vaccine doses ready to go by early 2021.
All in all, I think it’s quite likely that we get a Covid-19 vaccine by October or November, and that such a vaccine is easily and broadly accessible to the U.S. public by early 2021.
Rebounding Air Travel Demand
Easy and broad access to a Covid-19 vaccine will greatly diminish the public threat of coronavirus and spark rapid consumer behavior normalization.
Of course, this means that if a Covid-19 vaccine is broadly available to the public in early 2021, then air travel demand in 2021 will soar.
The thesis is simple.
Everyone is going to stir-crazy right now. We are all wanting to go on a vacation. But most of us are afraid to do so. A Covid-19 vaccine will reduce that fear significantly for most of us. As the fear of getting sick falls, pent-up demand to travel and go do things will turn into robust consumer spending on flights, hotels and vacations.
In numbers, I suspect 2021 air travel will rebound to about 80% of 2019 levels, and then bounce back to fully normal by 2022.
For Southwest Airlines, the recovery could be even swifter, because this is a low-cost, domestic airline (and demand for cheap, short flights will likely recover before demand for premium, long flights does).
As such, I think Southwest Airlines and LUV stock are due for big rebounds over the next 12 to 24 months.
LUV Stock is Undervalued
In my scenario where air travel demand does recover to 100% normal levels by 2022, then LUV stock has visible upside to over $40 over the next 12+ months.
Southwest’s revenues were around $22.4 billion in 2019. Let’s say 2022 revenues recover to that $22 billion level. Operating margins were 13% in 2019. They’ll never get that high again, because of additional costs from more thorough and consistent cleaning measures. Still, operating margins around 10% look likely by 2022.
A 10% operating margin on $22 billion in revenues implies 2022 operating profits of $2.2 billion. Take out 20% for taxes. You’re left with ~$1.8 billion in net profits. Divide by 500 shares outstanding. You’re talking about $3.50 in 2022 earnings per share.
Throw a historically average 12x forward earnings multiple on that and you get a 2021 price target for LUV stock of more than $40.
Bottom Line on LUV Stock
Air travel demand won’t remain depressed forever. Once a Covid-19 vaccine is broadly accessible to the public, pent-up consumer demand to travel will turn into robust consumer spending on flights.
That could happen in 2021/22. If it does, then LUV stock is due for a huge rally over the next 12+ months.
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.